Atfirstsight,investinginapoorprojecttogetachanceto
investinanevenpoorerprojectmayseemlikeabaddeal,but
thesecondinvestmentdoeshavearedeemingfeature.Itisan
optionandAmBevwillnotmakethesecondinvestment(of
$1billion) if theexpectedpresentvalue ofthecash flows
staysbelowthatnumber.Furthermore,thereisconsiderable
uncertaintyaboutthesizeandpotentialforthismarket,and
the firm may well find itself with a lucrative investment.
Toestimatethevalueofthesecondinvestmentasanoption,
we begin by first identifying the underlying asset—the
expansion project—and using the current estimate of
expectedvalue($750million)asthevalueoftheunderlying
asset.Sincetheinvestmentneededfortheinvestmentof$1
billionistheexerciseprice,thisoptionisout-of-the-money.
Thetwomostproblematicassumptionsrelatetothevariance
in the value of the underlying asset and the life of the option:
1.We estimatedtheaverage standarddeviationof 35%in
firmvaluesofsmall,publiclytradedbeveragecompaniesin
the UnitedStates and assumed that this would be a good
proxyforthestandarddeviationinthevalueoftheexpansion
option.
2.WeassumedthatAmBevwouldhaveafive-yearwindow
to make its decision. We admit that this is an arbitrary
constraintbut,intherealworld,itmaybedrivenbyanyof
the following:
- Financing constraints (loans coming due).
- Strategicprerogatives(wehavetochoosewhereour
resources will be invested).