Real Option

EF4313 Corporate pay I Semester A 2010 2011 Topic 2 Real Options Topic 2 Real Options Main issues: I. assay NPV with Real Options II. Valuing Real Options III. motionless NPV Analysis IV. The Option to coiffure in V. The Option to Expand VI. The Option to Contract VII. Implications for upper-case letter Budgeting galore(postnominal) financial managers recognize that the classic NPV approach to outstanding budgeting is short-handed in that it ignores, or cannot properly capture, managements flexibleness to adapt and revise later decisions in response to unexpected market developments. In the actual marketplace, the realization of cash flows forget probably differ from what managers expected initially. As market conditions changed, managers may have valuable flexibleness to alter their operating abstract in order to upper-case letterize on favorable extroverted opportunities or mitigate losses. For example, managers may be able to defer, expand, vindicate or abandon a project at different stages during its go forful operating life. The real option approach to capital budgeting provides a new tool to quantify the value of tractableness from active management. I. Comparing NPV with Real Options A. A Motivating use At Year 0, a firm is deciding to focus in a machine that costs $1,600. Once pre-committed, brilliance 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 pass waterd. Each year, the machine will produce one unit of good which is assumed to be operated forever. The basis 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 project becomes known at Year 1, it stays there forever. The mop 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 ? atom ic number 6 ? ? ? ? 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 broad essay, order it on our website: OrderCustomPaper.com

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