Real Option

EF4313 Corporate pay I Semester A 2010 2011 Topic 2 Real Options Topic 2 Real Options Main issues: I. show NPV with Real Options II. Valuing Real Options III. motionless NPV Analysis IV. The Option to ordinate in V. The Option to Expand VI. The Option to Contract VII. Implications for cap Budgeting galore(postnominal) financial managers recognize that the classic NPV approach to outstanding budgeting is short-staffed in that it ignores, or cannot properly capture, managements flexibleness 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 lineation in order to enceinteize on favorable extraverted opportunities or mitigate losses. For example, managers may be able to defer, expand, contract or abandon a proje ct at different stages during its partful operating life. The real option approach to capital budgeting provides a new tool to quantify the value of flexibleness from active management. I. Comparing NPV with Real Options A. A Motivating use At Year 0, a firm is deciding to come out in a machine that costs $1,600.

Once pre-committed, undecomposed unit of good is growd at the end of Year 1 and the capital cost will be paid at once the first good is pay backd. Each year, the machine will produce one unit of good which is assumed to be operated forever. The damage of the good is uncertain at Year 1. It w ill be worth either $300 or $ degree Celsius! with a 50/50 probability. But once the price trail becomes known at Year 1, it stays there forever. The clangor 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 ? vitamin C ? ? ? ? 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 rise essay, order it on our website: OrderCustomPaper.com

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