Real Options Illustrated by Linda Peters

By Linda Peters

This e-book explains the traditional actual suggestions research (ROA) literature in a simple, step-by-step demeanour with out using advanced arithmetic. loads of ROA literature is defined via partial differential equations, chance density features and simulation ideas, all of that could be unconvincing within the acceptable traits ROA possesses. utilizing this ebook, the reader may have a greater clutch approximately how ROA works and may be ready to offer his or her judgment approximately ROA, due to the fact all of the fundamentals, in addition to its confident and detrimental traits, are discussed.

Real strategies Illustrated provides practitioners with a true suggestions framework and encourages readers to check the technique utilizing the in-depth factors. This advent to ROA is enough to equip readers with ROA fundamentals, permitting them to accomplish destiny self sustaining study. From this ebook, readers can pass judgement on even if ROA is of any price to their field.

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Sample text

And from this we are able to model the underlying stochastic process for the project without flexibility. Note that an important property of the classical binomial tree is a recombining tree, therefore the event tree in this example is recombining and should remain recombining. In step 3 we will add the options to the event tree and this in turn will lead to a decision tree. In step 4 we will work backward through this decision tree using the replicating portfolio approach in order to obtain the real options value of the project.

In this case example we compute the base case present value without flexibility using discounted cash flow (DCF) valuation model. This is already done for the Portes case and it shows a negative NPV of $319 thousand. The reproduction of the calculation is shown in Fig. 13. From this it can be seen that the NPV result is negative and equals $318 thousand instead of $319 thousand. 8% Fig. 13 NPV analysis of the Portes case (2001c) doesn’t use the exact, but rounded values, which complicates the reproduction of the procedures and calculations.

Risk is one of the key-drives of project value, because it maximizes the upside potential and minimizes the downside risk. Risk is also called ‘volatility’ according to the real options terminology. The greater the expected risk or volatility, the higher the option or project value and hence the value of flexibility. • The level of interest rates. e. the option value. In case of a call option, higher discount rates result in lower costs to exercise the option, and therefore increases the price of a call option.

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