Lect 19 221 web

# Lect 19 221 web - Managerial Finance Lecture 19 Real...

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1 Managerial Finance Lecture 19 Real Options

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2 Andrea Korbes’ Options Assume Andrea stays with Yahoo until her options expire Assume Andrea stays with Yahoo until her options expire, and waits until then to exercise her options Then we can value the options as standard European Calls We can use the Black-Scholes Formula S = \$46 40 (current Yahoo stock price on 2/13/2004 = \$46.40 (current Yahoo stock price on 2/13/2004) Intrinsic Value Expiration Date Exercise Price Number of Options Years to Expiration Yahoo Volatility Interest Rate BS Grant 2 \$ 805,120 Total \$ 310,508 \$ - \$ 147,378 \$ 163,130 1/12/14 49.74 13,500 8/6/13 29.46 8,700 12/4/12 16.74 5,500 9.91 9.48 8.81 38.50% 38.50% 38.50% 4.0% 4.0% 4.0% \$ 25.14 \$ 30.82 \$ 35.91 \$ 339,406 \$ 268,189 \$ 197,525
3 Implied volatility What if you are interested in pricing Andrea’s options but the volatility was not given? Can use implied volatility = the volatility of an asset’s return that is consistent with the market prices of options on the asset Back-out the volatility of the underlying asset from option prices using the Black-Scholes formula Implied volatility estimates are typically based on prices of at-the-money options CURRENT ASSET PRICE (A) 46.400 EXERCISE PRICE (X) 45.000 DIVIDEND RATE (D) 0.00% RISKLESS RATE (R) 1.23% ERROR: VOLATILITY MUST BE > 0 TIME TO EXPIRATION (yrs) (T) 0.942 PRICE CALCULATOR STANDARD OPTION Exhibit 4b: Jan 2005 Call Strike = 45 C = 7.80 3 We can then go back and use this implied volatility in the B-S formula to value Andrea’s options CURRENT DATE 2/13/2004 EXPIRATION DATE 1/22/2005 QUOTED CALL PRICE 7.800 IMPLIED VOLATILITY 38.87%

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4 Real Options Real options : use of option valuation techniques to evaluate real investment projects (capital budgeting) Main applications: 1. Option to delay : most projects are not “now or never”. It may pay to wait until part of the uncertainty is resolved and then decide 2 Option to expand : by undertaking a project a firm often gets the 2. Option to : by undertaking a project, a firm often gets the opportunity to make investments that it would not otherwise have 3. Option to abandon : firms would be less valuable if they had to continue operating value-destroying projects Main idea : flexibility can be very valuable! Management can change investment decisions as a function of changing economic conditions • Only valuable future opportunities are pursued: we get option-like payoffs • Ignoring these options often leads to underinvestment and undervaluation 4
5 Apex International Global distributor of electronic parts raw materials Global distributor of electronic parts, raw materials,… Need for global network of storage and warehouse facilities, distribution centers Real estate portfolio Direct ownership or long term (capital) leases Direct ownership or long-term (capital) leases Short-term (operating) leases Options to buy and build Currently evaluating three possible actions : 1 Exercise the options now and “buy and build” 5 1. Exercise the options now and buy and build 2. Walk away 3. Extend the contracts for one additional year: ignored thus far!

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## This note was uploaded on 01/08/2012 for the course MS&E 245G taught by Professor Perez-gonzalas during the Fall '11 term at Stanford.

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Lect 19 221 web - Managerial Finance Lecture 19 Real...

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