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Unformatted text preview: 1 Lecture XXX Real Option Valuation I. Moss, Pagano, and Boggess. Ex Ante Modeling of the Effect of Irreversibility and Uncertainty on Citrus Investments. A. Traditional courses in financial management state that an investment should be undertaken if the Net Present Value of the investment is positive. 1. However, firms routinely fail to make investments that appear profitable considering the time value of money. 2. Several alternative explanations for this phenomenon have been proposed. However, the most fruitful involves risk. a. Integrating risk into the decision model may take several forms from the Capital Asset Pricing Model to stochastic net present value. b. However, one avenue, which has gained increased attention during the past decade, is the notion of an investment as an option. 3. Several characteristics of investments make the use of option pricing models attractive. a. In most investments, investors can be construed to have limited liability with the distribution being truncated at the loss the entire investment. b. Alternatively, Dixit and Pindyck have pointed out that the investment decision is very seldomly a now or never decision. The decision maker may simply postpone exercising the option to invest....
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- Fall '08