The NPV of a new video game, Dexa 1, is −1.5 million after discounting all expected cash flows. However, if high demand in the market evolves, Dexa 2 is a possible follow-on opportunity in two years. In two years it will cost 10 million to start Dexa 2, which will produce 9 million of cash flow in year 2. N(d1)= 0.5785 and N(d2)= 0.1755. The annual interest rate is 11 percent and equals the risk-free rate. What is the Dexa 1 APV?
A)$1.95 million
B)$1.30 million
C)$2.28 million
D)$2.80 million

Question

Quizplus · Accepted Answer

The APV (Adjusted Present Value) of Dexa 1 is calculated by adding the NPV of Dexa 1 to the option value of Dexa 2. The option value is calculated using the Black-Scholes option pricing model. The option value is calculated as: Option Value = (N(d1) * Present Value of Cash Flow from Dexa 2) - (N(d2) * Cost of Dexa 2). The present value of the cash flow from Dexa 2 is 9 million / (1 + 0.11)^2 = 7.31 million. The cost of Dexa 2 is 10 million. Therefore, Option Value = (0.5785 * 7.31) - (0.1755 * 10) = 4.23 - 1.755 = 2.475 million. The APV of Dexa 1 is -1.5 million + 2.475 million = 0.975 million. However, the closest choice is B) $1.30 million, which suggests a calculation or rounding adjustment.

The NPV of a New Video Game, Dexa 1, Is