Real Option

EF4313 Corporate pay I Semester A 2010 2011 Topic 2 Real Options Topic 2 Real Options Main issues: I. dissect NPV with Real Options II. Valuing Real Options III. motionless NPV Analysis IV. The Option to fix up in V. The Option to Expand VI. The Option to Contract VII. Implications for great(p) Budgeting galore(postnominal) financial managers recognize that the classic NPV approach to outstanding budgeting is undermanned in that it ignores, or cannot properly capture, managements flexibility to adapt and revise later decisions in response to unanticipated market developments. In the actual marketplace, the realization of cash flows go forth probably differ from what managers expected initially. As market conditions changed, managers may have valuable flexibleness to alter their operating outline in order to upper-case letterize on favorable coming(a) opportunities or mitigate losses. For example, managers may be able to defer, expand, exc apply or aban don a project at unalike stages during its useful operating life. The real option approach to capital budgeting provides a new tool to quantify the value of flexibility from active management. I. Comparing NPV with Real Options A. A Motivating use At Year 0, a firm is deciding to rank in a machine that costs $1,600.

Once pre-committed, supporter unit of good is growd at the end of Year 1 and the capital cost will be paid formerly the first good is kindled. Each year, the machine will produce one unit of good which is assumed to be operated forever. The undercoat of the good is uncertain at Year 1. It will be worth either $300 or $ degree Celsius with a 50/50 probability. But once the price carriage becomes known ! at Year 1, it stays there forever. The clangour aside rate is 10%. Should the firm invest? 1 EF4313 Corporate Finance I Semester A 2010 2011 Topic 2 Real Options (1) Static NPV Approach The NPV of this investment is: ? 300 ? degree centigrade ? ? ? ? NPV1 = ?0.5 × ? 300 + ? + 0.5 × ?100 + ? ? 1600 0.1 ? 0.1 ? ? ? ? ? ? = 600 NPV0 = 600 1.1 = 545.45 According...If you want to get a beat essay, order it on our website: OrderEssay.net

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