FINE 332 3.2 Real Options and Decision Trees

Zion Aviation Rates: Discount rate Risk-free rate 7.5% 4.5% Start Cash from Operations minus: Capital Expenditures = Net Cash Flow (NCF) Terminal Value PV of NCF Cash from Operations minus: Capital Expenditures = Net Cash Flow (NCF) Terminal Value PV of NCF PV of Cap. Ex. (Yrs. 1-2) 4.0 1 6.0 5.0 Scenario: No Real Options 2 3 4 5 7.0 8.5 8.5 9.0 5.0 4.0 5.0 5.0 6 11.0 5.0 7 12.0 5.0 11.0 Start 4.0 1 6.0 Scenario: Real Options 2 3 4 5 7.0 8.5 8.5 9.0 4.0 5.0 5.0 6 11.0 5.0 7 12.0 5.0 11.0 Option Pricing: PV of Cap. Ex. (Yrs. 1-2) Maturity PV of NCF Risk free rate Volatility BS calculations: d1 N(d1) d2 N(d2) Price of call Difference: – Value of Option over PV – % of PV 4.0 20% #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! Start Phase I Network Expansion with New Aircraft PV of Phase II Phase III Revenues Costs Success 185 80% 18 Utah 25% 15 Failure 20% 10 Success 70% 27 179 Failure 30% 12 – Success 67% 25 146 Failure 33% 11 – Colorado 25% 16 Success 65% 19 Arizona 22% 20 Start 14 Failure 28% 11 Failure 35% 13 – – Aircraft Net Total Probability Expected Value No content – Intentionally left blank

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