Ch26 Tropical Sweets Real Options Mini Case - 4/11/2010...

4/11/2010
Chapter 25. Real Options
Demand Prob.
Assume that you have just been hired as a financial analyst by Tropical Sweets Inc., a mid-sized California
company that specializes in creating exotic candies from tropical fruits such as mangoes, papayas, and dates. The
firm's CEO, George Yamaguchi, recently returned from an industry corporate executive conference in San
Francisco, and one of the sessions he attended was on real options. Since no one at Tropical Sweets is familiar
with the basics of real options, Yamaguchi has asked you to prepare a brief report that the firm's executives could
use to gain at least a cursory understanding of the topics.
a.
High 0.3 $45 $13.50
Average 0.4 $30 $12.00
Low 0.3 $15 $4.50
Expected CF= $30.00
Procedure 1: DCF Only
Year 1 2 3
Expected CF $30.00 $30.00 $30.00
NPV= $4.61
e. Use decision tree analysis to calculate the NPV of the project with the investment timing option.
d. Now suppose this project has an investment timing option, since it can be delayed for a year. The cost will still
be $70 million at the end of the year, and the cash flows for the scenarios will still last three years. However,
Tropical Sweets will know the level of demand, and will implement the project only if it adds value to the
company. Perform a qualitative assessment of the investment timing option’s value. Answer: See Chapter 25
Mini Case Show

Procedure 3: Decision Tree Analysis
a. Scenario Analysis: Proceed with Project Today
Cost Future Cash Flows NPV this Prob. Data for
Year 0 Prob. 1 2 3 Scenario x NPV Std Deviation
$45 $45 $45 $41.91 $12.57
417
30%
-$70 40% $30 $30 $30 $4.61 $1.84
0
30%
$15 $15 $15 -$32.70 -$9.81
417
Expected NPV of Future CFs = $4.61
835
Standard Deviation= $28.89
Coefficient of Variation = 6.27
b. Decision Tree Analysis: Implement in One Year Only if Optimal
Cost Future Cash Flows NPV this Prob. Data for
Year 0 Prob. 1 2 3 4 x NPV Std Deviation
-$70 $45 $45 $45 $35.70 $10.71
177
30%
$0 40% -$70 $30 $30 $30 $1.79 $0.71
37
30%
$0 $0 $0 $0 $0.00 $0.00
39