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An Introduction to Options, other Derivative Securities, and the Real Options Method prof Karl V. Lins A Weakness in the NPV Approach to Evaluating Proposals When estimating the hereafter hard currency flows associated ith l f with a proposal, it i diffi lt to fully forego for is delicate t f ll ll managerial flexibility. As succession goes by, you provide learn more about the technology involved, grocery demand, contest responses, etc., And you imparting react to the new information, e.g. by change magnitude production, exiting the market or other production market, appropriate response. How gutter your future optimal reactions be mothern into account in evaluating whether to gussy up the proposal? By use of survival of the fittest pricing approaches. 1 strategic Thinking and Capital Budgeting: An Introduction to Real Options Is it reclaimable to give the option to defer making an investment? bewilder A will generate risk free cash flows of $10,00 0 per category forever. The risk free raise rate is 10% per period. It would take an immediate investment of $110,000 to launch the depict. NPV = 10,000/.10-110,000=100,000-110,000 = -$10,000 Someone offers you $1 for the rights to this parturiency. Do you take it? Hint: Do mines that are currently not operated have a zero market value? The hold Option No!

Suppose that one course from now interest rates will be every 8% or 12% with equal probability. However, the cash flows associated with this project are not sensitive to interest rates --they will be as indicated above, regardless. Next year, NPV=10,000/.08-110,000=125,000-110,000 = 15,! 000, or NPV=10,000/.12-110,000=83,333-110,000 = -$26,666 Dont give up the rights to the project yet! You can arrest until next year, and indeed commence the project if it proves profitable at the time. There is a 50% chance the project will be cost $15,000 next year! As a consequence, the project has value now due to the presence of a deferral option. 2 The option to abandon a project To initiate a...If you want to get a full essay, secern it on our website: OrderCustomPaper.com

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