finance - Chapter 13 Real Options and Other Topics in...

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Unformatted text preview: Chapter 13 Real Options and Other Topics in Capital Budgeting Learning Objectives After reading this chapter, the student should be able to: Explain why conventional NPV analysis may not capture a projects impact on the firms opportunities. Identify five different types of real options. Explain what an abandonment/shutdown option is, give an example of a project that includes this type of option, and explain what an option value is. Explain what a decision tree is and provide an example of one. Explain what an investment timing option is, and give an example of a project that includes one. Explain what a growth option is, and give an example of a project that includes one. Explain what a flexibility option is, and give an example of a project that includes one. Use the replacement chain and equivalent annual annuity methods to compare projects with unequal lives, and explain when you might use one method over the other. List the steps a firm goes through when establishing its optimal capital budget in practice. Chapter 13: Real Options Learning Objectives 85 Lecture Suggestions This chapter covers some important but relatively technical topics. Note too that this chapter is more modular than most, i.e., the major sections are discrete, hence they can be omitted without loss of continuity. Therefore, if you are experiencing a time crunch, you could skip sections or even the entire chapter. What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case solution for Chapter 13, which appears at the end of this chapter solution. For other suggestions about the lecture, please see the Lecture Suggestions in Chapter 2, where we describe how we conduct our classes. DAYS ON CHAPTER: 2 OF 58 DAYS (50-MINUTE PERIODS) 86 Lecture Suggestions Chapter 13: Real Options Answers to End-of-Chapter Questions 13-1 a. An abandonment option is the option to abandoning a project if operating cash flows turn out to be lower than expected. This option can both raise expected profitability and lower project risk, because in the case of poor cash flows, the project can be ended and rather than continue realizing negative cash flows, fixed assets are sold and some cash is recovered. b. An investment timing option occurs when a firm has the option of delaying the start of a project until additional information can be obtained. After the delay, if conditions for the project look unfavorable, the project will not be undertaken, while if conditions are favorable then the project proceeds as usual. However, there are some drawbacks to relying on investment timing proceeds as usual....
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This note was uploaded on 01/07/2012 for the course BBA 101 taught by Professor Jhon during the Spring '10 term at Acton School of Business.

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finance - Chapter 13 Real Options and Other Topics in...

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