Chapter Brealey, Myers, and Allen Principles of Corporate Finance 11th Edition REAL OPTIONS 22...
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Transcript of Chapter Brealey, Myers, and Allen Principles of Corporate Finance 11th Edition REAL OPTIONS 22...
Chapter
Brealey, Myers, and Allen
Principles of Corporate Finance
11th Edition
REAL OPTIONS
22
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
22-2
22-1 VALUE OF FOLLOW-ON INVESTMENT OPPORTUNITIES
• Four Types of Real Opinions • Opportunity to expand, make follow-up investments
• Opportunity to wait, invest later
• Opportunity to shrink or abandon project
• Opportunity to vary firm’s output or production methods
• Value of real option = NPV with option
− NPV without option
22-3
TABLE 22.1 CASH FLOW AND FINANCIAL ANALYSIS OF MARK I MICROCOMPUTER
• Mark I Microcomputer in Millions
22-7
FIGURE 22.1 POSSIBLE PRESENT VALUES FOR MARK II IN 1985
• Distribution shows range of possible present values for Mark II project 1985
• Expected value roughly $800 million (less than required investment of $900 million)
• Option to invest pays off in shaded area above $900 million
22-10
22-2 TIMING OPTION
• Intrinsic value plus time premium equals option value
• Time premium equals value of being able to wait
Opt
ion
pric
e
Stock price
22-12
FIGURE 22.2 TIMING OPTION EXAMPLE
• Possible cash flow and end-of-period values for malted herring project shown in black
• Project costs $180 million
• Red figures in parentheses show payoffs from option to wait and invest later in project, now positive-NPV at year 1
• Waiting means loss of first year cash flow; figuring out current value of option is difficult
22-14
22-2 TIMING OPTION
• High demand generates $25 million, $250 million value at end of year
• Low demand generates $16 million with no value
High Demand Low Demand
375.
1200
)25025(return Total
12.
1200
)16016(return Total
Risk neutral return
22-15
22-2 TIMING OPTION
• Calculate probability of high demand for malted herring project
• Option value
343. demandhigh of Prob
05.return Expected
(-.12)demand)high of prob1(375.demand)high of prob(return Expected
22-17
22-3 ABANDONMENT OPTION
• Example • Mrs. Mulla gives nonretractable offer to buy company for $150 million at anytime within next year
• Given possible outcomes
• What is value of offer?
• What is most Mrs. Mulla could charge for that option?
• Use discount rate of 10%
22-18
22-3 ABANDONMENT OPTION
Year 0 Year 1 Year 2
120 (.6)
100 (.6)
90 (.4)
NPV = 145
70 (.6)
50 (.4)
40 (.4)
•Example
22-19
22-3 ABANDONMENT OPTION
Year 0 Year 1 Year 2
120 (.6)
100 (.6)
90 (.4)
NPV = 162
150 (.4)
Option value =
162 − 145 =
$17 Million
22-23
FIGURE 22.6 AIRCRAFT PURCHASE OPTION
• If implemented at year 3, option guarantees fixed price and delivery at year 4
• Without option, plane can still be ordered at year 3 but with uncertain price and delivery
22-26
22-6 CONCEPTUAL PROBLEM
• Real options are not always feasible to use• Options can be complex; it is sometimes impossible to arrive at “perfect” answer
• No clear structure to path and cash flows
• Competitors have real options, which alter option values by altering underlying assumptions and environment that serves as basis of valuation