Real Option

EF4313 Corporate pay I Semester A 2010 2011 Topic 2 Real Options Topic 2 Real Options Main issues: I. discover NPV with Real Options II. Valuing Real Options III. motionless NPV Analysis IV. The Option to establish 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 undermanned in that it ignores, or cannot properly capture, managements flexibleness to adapt and revise later decisions in response to unforeseen market developments. In the actual marketplace, the realization of cash flows give probably differ from what managers expected initially. As market conditions changed, managers may have valuable flexibleness to alter their operating schema in order to metropolisize on favorable extroverted opportunities or mitigate losses. For example, managers may be able to defer, expand, trim down or abandon a project at unlike stages during its intakeful 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 position in a machine that costs $1,600.

Once pre-committed, salutary unit of good is growd at the end of Year 1 and the capital cost will be paid once the first good is reachd. Each year, the machine will produce one unit of good which is assumed to be operated forever. The dry land of the good is uncertain at Year 1. It will be w orth either $300 or $ degree Celsius with a ! 50/50 probability. But once the price prey becomes known at Year 1, it stays there forever. The coppice 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 ? cytosine ? ? ? ? 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 undecomposed essay, order it on our website: OrderCustomPaper.com

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