Real Options - Chapters 10 and 22 (exam 2)-3

Real Options - Chapters 10 and 22 (exam 2)-3 - Real Options...

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Real Options Chapters 10 and 22
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Topics Covered The Value of Follow-On Investment Opportunities The Timing Option The Abandonment Option Flexible Production A Conceptual Problem
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Real Options 1. Option to expand 2. Option to abandon 3. Timing option 4. Flexible production facilities
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Decision Trees - Diagram of sequential decisions and possible outcomes. Decision trees help companies determine their Options by showing the various choices and outcomes. The Option to avoid a loss or produce extra profit has value. The ability to create an Option thus has value that can be bought or sold.
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Decision Trees Setup: Drug trials Already passed phase one of trial Two phase remain Phase two takes two years Phase three takes three years Cost of capital for project is 9.6%
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Decision Trees $700 (.80) $ 0 (.20) $ 300 (.80) $ 0 (.20) $ 100 (.80) $ 0 (.20) Invest Yes / No NPV= ? - $18 - $130 - $130 - $130 .25 .50 .25 $ 0 .44 .56
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Decision Trees $700 (.80) $ 0 (.20) $ 300 (.80) $ 0 (.20) $ 100 (.80) $ 0 (.20) 560 240 80 Invest Yes / No NPV= ? - $18 - $130 - $130 - $130 .25 .50 .25 $ 0 .44 .56
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Decision Trees $700 (.80) $ 0 (.20) $ 300 (.80) $ 0 (.20) $ 100 (.80) $ 0 (.20) 560 240 80 Invest Yes / No NPV= ? - $18 - $130 - $130 - $130 .25 .50 .25 $ 0 .44 .56 NPV = $295 NPV = $52 NPV = - $69 (do not invest, so NPV = 0)
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Decision Trees $700 (.80) $ 0 (.20) $ 300 (.80) $ 0 (.20) $ 100 (.80) $ 0 (.20) 560 240 80 Invest Yes / No NPV= $19 - $18 - $130 - $130 - $130 .25 .50 .25 $ 0 .44 .56 NPV = $295 NPV = $52 NPV = - $69 (do not invest, so NPV = 0) E[PV] = $37
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Corporate Options 4 types of “Real Options” 1 - The opportunity to expand and make follow-up investments. 2 - The opportunity to “wait” and invest later.
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Real Options - Chapters 10 and 22 (exam 2)-3 - Real Options...

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