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86 Corporate Finance Real options 10. Real options
In many investment projects the firm faces one or more options to make strategic changes during its
lifetime. A classical example is mining firm's option to suspend extraction of natural resources if the price
falls below the extraction costs. Such strategic options are known as real options, and, can significantly
increase the value of a project by eliminating unfavourable outcomes.
Generally there exist four types of “real options”:
4. The opportunity to expand and make follow-up investments
The opportunity to “wait” and invest later
The opportunity to shrink or abandon a project
The opportunity to vary the mix of the firm’s output or production methods 10.1 Expansion option
The option to expand is often imbedded in investment projects. The value of follow-on investments can be
significant and in some case even trigger the project to have positive NPV.
Examples of options to expand:
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This note was uploaded on 10/26/2012 for the course 19 19 taught by Professor - during the Spring '12 term at Sunway University College.
- Spring '12