FIN 4414 Lecture Notes - Lecture 18: Real Options Valuation, Net Present Value
21 Mar 2017
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> managers can influence the size & riskiness of a project"s cash flows by taking different actions during the projects life. > typical npv budgeting analysis with an analysis for opportunities resulting from managers" decisions: examples of real options. Increased volatility makes the option to delay more attractive: proper discount rate. To correctly solve for the value of an option, we need to borrow ideas from option pricing. Using decision-tree analysis is helpful for framing the problem but provides little insights into proper discount rate. Real option valuation is the other approach that avoids the issues of selecting the discount rate: setting up real option valuation. Create a twin security that has payoffs proportional to the underlying asset. Create a replicating portfolio where you purchase some combination of the twin security & risk free bonds that yield payoffs in the two states that are identical to the contingent payouts found from dta.
