SENSITIVITY OF NET PRESENT VALUES AND REAL OPTION VALUES TO

In export operation forecasting exercises the effect of stochastic inputvariables such as exchange rates and commodity prices are often ignoredwith the convention being to account for their uncertainty in discount rates. Inthe case where exchange rates are highly volatile, such as in the developingworld, their effect on the uncertainty surrounding forecast Net Present Value(NPV) of the project can be pronounced.The objective of this research is to evaluate the effect of exchange ratevolatility on NPV uncertainty or standard deviation. This is done in thecontext of a forecasting model used to determine the profitability of aproposed copper refinery. The analysis measures NPV mean and standarddeviation for a range of exchange rate volatilities and evaluates their effect onthese statistics. The research further considers what effect this has on thereal option value of deferring the decision to invest. In considering practicalmitigation of this currency risk a further analysis is done in which a simplehedging strategy is used.The results indicate that for an exchange rate volatility range of 0.5% to 10%(being a typical spread of stable economies around the world), there is nosignificant impact on NPV uncertainty. With real option value linked to theNPV standard deviation, this results in no significant effect on option value.Lastly, the results show that the simple hedging strategy does very little inreducing the effect of currency risk on NPV uncertainty.