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Chapter 13 - CHAPTER13 CapitalBudgeting 131 cashf

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    13-1 CHAPTER 13 Real Options and Other Topics in  Capital Budgeting Identifying embedded options Valuing real options in projects Evaluating projects with unequal lives
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    13-2 What 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’  decisions.
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    13-3 What are some examples  of real options? Investment timing options Abandonment/shutdown options Growth/expansion options Flexibility options
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    13-4 Investment 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 with  the project. However, if the company waits a year they will  find out more about the project’s expected cash  flows.    
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    13-5 Investment 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.
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