forajointventure.Eachfirmwillinvest$500millioninthe
joint venture and produce the planes. The investment is
expected to have a 30-year life. Airbus works through a
traditionalinvestmentanalysisandconcludesthatitsshareof
thepresentvalueoftheexpectedcashflowswouldbeonly
$480 million. The net present value of the project would
thereforebenegativeandAirbuswouldnotwanttobepartof
this joint venture.
Onrejectionofthejointventure,LearapproachesAirbuswith
asweetener,offeringtobuyoutAirbus’s50%shareofthe
jointventureatanytime overthenextfiveyearsfor $400
million.ThisislessthanwhatAirbuswillinvestinitiallybut
itputsaflooronitspossiblelossesandthusgivesAirbusan
abandonmentoption.TovaluethisoptiontoAirbus,notethat
the inputs are as follows:
To estimate the variance, assume that Airbus employs a
MonteCarlosimulationontheprojectanalysisandestimates
a standarddeviationinproject valueof25%. Finally,note
thatsincetheprojecthasafinitelife,thepresentvaluewill
declineovertime,becausetherewillbefeweryearsofcash
flowsleft.Forsimplicity,we willassumethat thiswillbe
proportional to the time left on the project:
InputtingthesevaluesintotheBlack-Scholesmodelandusing
a 5% riskless rate, we value the put option.