Project Valuation Using Real Options

A Practitioner's Guide

By: Chandra Papudesu, Prasad S. Kodukula Kodukula

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Hardcover | 30 July 2006

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256 Pages

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23.6 x 15.2 x 1.6

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Business leaders are frequently faced with investment decisions on new and ongoing projects. The challenge lies in deciding what projects to choose, expand, contract, defer, or abandon, and which method of valuation to use is the key tool in the process. This title presents a step-by-step, practical approach to real options valuation to make it easily understandable by practitioners as well as senior management. This systematic approach to project valuation helps you minimize upfront investment risks, exercise flexibility in decision making, and maximize the returns. Whereas the traditional decision tools such as discounted cash flow/net present value (DCF/NPV) analysis assume a ""fixed"" path ahead, real options analysis offers more flexible strategies. Considered one of the greatest innovations of modern finance, the real options approach is based on Nobel-prize winning work by three MIT economists, Fischer Black, Robert Merton, and Myron Scholes.

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Non-Fiction Business & Management Management & Management Techniques Project Management Accounting & Finance Finance Corporate Finance Business Strategy Management of Specific Areas Budgeting & Financial Management

Preface	p. ix
Acknowledgments	p. xiii
About the Authors	p. xv
Web Added Value	p. xvii
Introduction	p. 1
Financial Options Example	p. 1
Options Terminology	p. 2
Financial Versus Real Options	p. 5
Real Options Examples	p. 5
Options Valuation	p. 10
Problems	p. 11
Traditional Project Valuation Tools	p. 13
Project Cash Flows	p. 15
Discount Rate	p. 15
Contingent Decisions	p. 15
Present Value	p. 16
Discounted Cash Flow Method	p. 17
Monte Carlo Simulation	p. 21
Decision Tree Analysis	p. 26
Problems	p. 33
Challenges with Traditional Tools	p. 35
Risks	p. 35
Definition of Risk	p. 36
Types of Risks	p. 38
Discount Rate Dilemma	p. 39
Weighted Average Cost of Capital	p. 42
Capital Asset Pricing Model	p. 43
WACC-Based Discount Rates	p. 44
Hurdle Rate	p. 45
Opportunity Cost	p. 45
Discounted Cash Flow Method	p. 47
Monte Carlo Simulation	p. 48
Decision Tree Analysis	p. 49
Next Level of Project Valuation	p. 49
Problems	p. 50
Real Options Analysis: The New Tool	p. 53
How Is Real Options Analysis Different?	p. 53
A Deferral Option	p. 54
Effect of Uncertainty	p. 55
Discounted Cash Flow Versus Real Options	p. 56
Decision Tree Analysis Versus Real Options Analysis	p. 57
When Is Real Options Analysis Most Valuable?	p. 58
Why Is Real Options Analysis Valuable?	p. 60
Types of Options	p. 61
Examples of Different Types of Options	p. 62
Problem	p. 64
Real Options Analysis Calculations	p. 65
Partial Differential Equations	p. 67
Black-Scholes Equation	p. 67
Simulations	p. 68
Lattices	p. 70
Binomial Lattice	p. 70
Other Lattices	p. 71
Binomial Method: Solution	p. 72
Real Options Analysis Example	p. 74
Problem	p. 74
Solution	p. 75
Black-Scholes Equation	p. 75
Monte Carlo Simulation	p. 75
Binomial Method	p. 76
Analysis	p. 80
Problem	p. 82
Real Options Analysis Application	p. 83
Limitations to Applying Financial Option Models to Real Options Analysis	p. 83
Estimation of Input Variables	p. 85
Underlying Asset Value	p. 85
Volatility of the Underlying Asset Value	p. 86
What Is Volatility?	p. 86
Sources of Volatility	p. 87
Methods to Estimate Volatility	p. 88
Logarithmic Cash Flow Returns Method	p. 88
Monte Carlo Simulation	p. 90
Project Proxy Approach	p. 91
Market Proxy Approach	p. 91
Management Assumption Approach	p. 91
Change in Volatility Over the Option Life	p. 92
Exercise or Strike Price	p. 92
Option Life	p. 93
Time Increments in the Model Framework	p. 93
Risk-Free Interest Rate	p. 94
What Is the Right Model?	p. 94
Black-Scholes Equation	p. 94
Simulations	p. 95
Binomial Method	p. 96
Real World Application of Real Options Solutions	p. 96
A Six-Step Process	p. 97
Problems	p. 99
Simple Options	p. 101
Option to Abandon	p. 102
Option to Abandon with Varying Strike Price	p. 108
Option to Expand	p. 110
Option to Contract	p. 116
Option to Choose	p. 121
Option to Wait	p. 126
Barrier Options	p. 130
Barrier Put Option	p. 131
Barrier Call Option	p. 137
Problems	p. 141
Advanced Options	p. 145
Compound Options (Option to Stage)	p. 146
Sequential Option	p. 146
Parallel Option	p. 156
Rainbow Options	p. 162
Options with Changing Volatility	p. 168
Integration of Decision Trees into Real Options Analysis	p. 174
Example	p. 174
Solution	p. 175
	p. 175
Real Options Analysis	p. 175
Decision Tree Analysis	p. 178
	p. 179
Analysis	p. 183
Discounted Cash Flow	p. 185
Decision Tree Analysis	p. 186
Other Advanced Options	p. 187
Problems	p. 189
Real Options in the Real World	p. 193
How Does a Practitioner Use Real Options Analysis?	p. 196
What Is the Status of Real Options in the Corporate World?	p. 198
How to Make Real Options Work in Your Organization	p. 201
References	p. 205
Replicating Portfolio	p. 207
Real Options Analysis Application Assessment Tool	p. 211
Notation	p. 215
A Glossary of Terms	p. 217
Index	p. 223
Table of Contents provided by Ingram. All Rights Reserved.

Project Valuation Using Real Options

A Practitioner's Guide

At a Glance

Hardcover

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Defective items

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