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 consecrate in V. The Option to Expand VI. The Option to Contract VII. Implications for jacket 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 tractability to adapt and revise later decisions in response to out of the blue(predicate) market developments. In the actual marketplace, the realization of cash flows exit probably differ from what managers expected initially. As market conditions changed, managers may have valuable flexibleness to alter their operating synopsis in order to peachyize on favorable extraverted opportunities or mitigate losses. For example, managers may be able to defer, expand, make out or abandon a project at unalike stages during its wontful 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 rank in a machine that costs $1,600.

Once pre-committed, right unit of good is growd at the end of Year 1 and the capital cost will be paid erst the first good is assignd. Each year, the machine will produce one unit of good which is assumed to be operated forever. The background 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 hire becomes known at Year 1, it stays there forever. The confrontation 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 Celsius ? ? ? ? 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 unspoiled essay, order it on our website: OrderCustomPaper.com

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