{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Ch 25 Toolkit

# Ch 25 Toolkit - Chapter 25 Tool Kit for Real Options THE...

This preview shows pages 1–4. Sign up to view the full content.

Chapter 25. Tool Kit for Real Options WACC= 14% Risk-free rate = 6% Initial cost of project= \$50 DCF Analysis Expected annual cash flows (in millions): Probability Cash Flow Prob. x CF 25% \$33 \$8.25 50% \$25 \$12.50 25% \$5 \$1.25 Expected CF = \$22.00 Time Line Year 0 1 2 3 Expected CF (\$50) \$22.00 \$22.00 \$22.00 NPV = \$1.08 Figure 25-1 DCF and Decision Tree Analysis for the Investment Timing Option (Millions of Dollars) Part 1. Scenario Analysis: Proceed with Project Today Future Cash Flows NPV of this Now: Year 0 Year 1 Year 2 Year 3 Probability \$33 \$33 \$33 \$26.61 0.25 High -\$50 Average \$25 \$25 \$25 \$8.04 0.50 Low \$5 \$5 \$5 -\$38.39 0.25 THE INVESTMENT TIMING OPTION: AN ILLUSTRATION (Section 25.2) Murphy Systems is considering a project that will create a new type of hand-held device for conn the Internet. The cost of the project is \$50 million, but the future cash flows are uncertain. Murp estimates a 25% probability that the new Internet device will be very popular in which case the p generate cash flows of \$30 million each year for three years. There is a 50% probability generati flows of \$25 million each year for three years. Unfortunately, there is a 25% chance that the Inte will not be popular, which means that the project will generate only \$5 million per year in cash flo cost of capital for this project is 14%. Scenario c 0. 25 0. 2 0. 5 0

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
1.00 Expected value of NPVs = Part 2. Decision-Tree Analysis: Implement in One Year Only If Optimal Future Cash Flows NPV of this Now: Year 0 Year 1 Year 2 Year 3 Year 4 Probability -\$50 \$33 \$33 \$33 \$23.35 0.25 High Wait Average -\$50 \$25 \$25 \$25 \$7.05 0.50 Low \$0 \$0 \$0 \$0 \$0.00 0.25 1.00 Expected value of NPVs = Notes: Figure 25-2 Sensitivity Analysis for the Investment Timing Option Decision Tree (Millions of Dollars) Future Cash Flows NPV of this Now: Year 0 Year 1 Year 2 Year 3 Year 4 Probability -\$50 \$33 \$33 \$33 \$20.04 0.25 High Average -\$50 \$25 \$25 \$25 \$3.74 0.50 Low \$0 \$0 \$0 \$0 \$0.00 0.25 Standard Deviation a = Coefficient of Variation b = Scenario d Standard Deviation a = Coefficient of Variation b = a The standard deviation is calculated as in Chapter 6. b The coefficient of variation is the standard deviation divided by the expected value c The WACC is 14%. d The NPV in Part 2 is as of Year 0. Therefore, each of the project cash flows is disc back one more year than in Part 1. Part 1. Decision-Tree Analysis: Implement in One Year Only If Optimal (Discount Cost at the Risk-Free Rate and Operating Cash Flows at the WACC) Scenario c 2 5 0. 25 0. 25 0. 5 0 0 . 2 5 0. 0. 50
1.00 Expected value of NPVs = Cost of Capital Used to Discount the Year 1 Cost \$6.88 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 8.0% \$13.11 \$13.46 \$13.80 \$14.14 \$14.47 \$14.79 9.0% \$11.78 \$12.13 \$12.47 \$12.81 \$13.14 \$13.47 10.0% \$10.50 \$10.85 \$11.20 \$11.53 \$11.86 \$12.19 11.0% \$9.27 \$9.62 \$9.97 \$10.30 \$10.64 \$10.96 12.0% \$8.09 \$8.44 \$8.78 \$9.12 \$9.45 \$9.78 13.0% \$6.95 \$7.30 \$7.64 \$7.98 \$8.31 \$8.64 14.0% \$5.85 \$6.20 \$6.54 \$6.88 \$7.21 \$7.54 15.0% \$4.79 \$5.14 \$5.48 \$5.82 \$6.15 \$6.48 16.0% \$3.77 \$4.12 \$4.46 \$4.80 \$5.13 \$5.45 17.0% \$2.78 \$3.13 \$3.47 \$3.81 \$4.14 \$4.46 18.0% \$1.83 \$2.18 \$2.52 \$2.86 \$3.19 \$3.51 Notes: Real Option Analysis Standard Deviation a = Coefficient of Variation b = Part 2. Sensitivity Analysis of NPV to Changes in the Cost of Capital Used to Discount Cost and Cash Flows Cost of Capital Used to Discount the Year-2 through Year-4 Operating Cash Flows a The standard deviation is calculated as in Chapter 6.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}