ch 13 - 13-1Real Options and Other Topics in Capital...

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Unformatted text preview: 13-1Real Options and Other Topics in Capital BudgetingChapter 13§Identifying Embedded Options§Valuing Real Options in Projects113-113-2What is real option analysis?§Real options exist when managers can influence the size and riskiness of a project’s cash flows by taking different actions during the project’s life.§Real option analysis incorporates typical NPV budgeting analysis with an analysis for opportunities resulting from managers’ 13-3What are some examples of §Growth/expansion options§Abandonment/shutdown options§Investment timing options§Flexibility options13-4Investment Timing Option§Project X has an up-front cost of $100,000. The project is expected to produce after-tax cash flows of $33,500 at the end of each of the next four years (t = 1, 2, 3, and 4). The project has a WACC=10%. §The project’s NPV is $6,190. Therefore, it appears that the company should go ahead 13-5Investment Timing Option§If they wait a year:§There is a 50% chance the market will be strong and the expected cash flows will be $43,500 a year for four years.§There is a 50% chance the market will be weak and the expected cash flows will be $23,500 a year for four years.§The project’s initial cost will remain $100,000, but it will be incurred at t = 1 only if it makes sense at that time to proceed with the project.13-6Investment Timing Decision §At WACC = 10%, the NPV at t = 1 is:§$37,889, if CF’s are $43,500 per year, or...
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This note was uploaded on 02/09/2010 for the course BUS 101 taught by Professor Noname during the Spring '10 term at KCTCS.

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ch 13 - 13-1Real Options and Other Topics in Capital...

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