Real Option

EF4313 Corporate pay I Semester A 2010 2011 Topic 2 Real Options Topic 2 Real Options Main issues: I. turn up NPV with Real Options II. Valuing Real Options III. motionless NPV Analysis IV. The Option to typeset in V. The Option to Expand VI. The Option to Contract VII. Implications for crown 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 tractability to adapt and revise later decisions in response to unanticipated market developments. In the actual marketplace, the realization of cash flows entrust probably differ from what managers expected initially. As market conditions changed, managers whitethorn have valuable flexibleness to alter their operating strategy in order to uppercaseize on favorable coming(a) opportunities or mitigate losses. For example, managers may be able to defer, expand, abbreviate or abando n a project at unlike stages during its wasting diseaseful operating life. The real option approach to capital budgeting provides a new tool to quantify the value of tractability from active management. I. Comparing NPV with Real Options A. A Motivating use At Year 0, a firm is deciding to localise in a machine that costs $1,600.

Once pre-committed, honest unit of good is growd at the end of Year 1 and the capital cost will be paid at a time the first good is stated. Each year, the machine will produce one unit of good which is assumed to be operated forever. The priming of the good is uncertain a t Year 1. It will be worth either $300 or $ ! degree Celsius with a 50/50 probability. But once the price get hold of becomes known at Year 1, it stays there forever. The showdown 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 ? coke ? ? ? ? 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 near essay, order it on our website: OrderCustomPaper.com

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