Real Option

EF4313 Corporate pay I Semester A 2010 2011 Topic 2 Real Options Topic 2 Real Options Main issues: I. try NPV with Real Options II. Valuing Real Options III. motionless NPV Analysis IV. The Option to put in V. The Option to Expand VI. The Option to Contract VII. Implications for chief city 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 tractableness 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 lineation in order to crackingize on favorable upcoming opportunities or mitigate losses. For example, managers may be able to defer, expand, lop or abandon a project at u nlike stages during its theatrical roleful 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 range in a machine that costs $1,600.

Once pre-committed, sound 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 dod. 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 contract becomes known at Year 1, it stays there forever. The face-off 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 ? century ? ? ? ? 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 fully essay, order it on our website: OrderCustomPaper.com

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