...Real Options in Corporate Finance Ellen Bjarnadóttir Thesis of 30 ECTS credits Master of Science in Financial Engineering June 2013 i Real Options in Corporate Finance (Notkun Raunvilnana við töku Fjárfestingaákvarðana) Ellen Bjarnadóttir Thesis of 30 ECTS credits submitted to the School of Science and Engineering at Reykjavík University in partial fulfillment of the requirements for the degree of Master of Science in Financial Engineering June 2013 Supervisor: Dr.Sverrir Ólafsson. Professor in Financial Mathematichs, Reykjavík University, Iceland Examiner: Dr. Rögnvaldur Sæmundsson Associate Professor, Reyjavík University, Iceland. ii Abstract The way companies value their investment opportunities has changed in recent years. With changing market conditions companies are constantly confronted with investment decisions that are increasingly uncertain. Known investment analysis such as net present value and decision tree analysis increasingly undervalue investment opportunities as they lack the flexibility and ability to modify projects when new information is available. A method based on financial option valuation has become the basis for a new technique to value high risk investment opportunities. It is based on valuation in the risk-neutral world and therefore eliminates investors’ attitude to risk. Real option analysis can capture the value of this increased flexibility, which previous methods have not been able to, such as the option to defer, abandon...
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...Drivers for Change 4 1.1.4 Business Outcomes 4 1.2 Strategic Fit 4 1.3 Detailed Description of the Business Need 5 1.3.1 Problem/Opportunity Statement 5 1.3.2 Prioritized Requirements (High Level) 5 1.3.3 Assumptions 5 1.3.4 Constraints 5 1.3.5 Dependencies 5 1.4 Scope 5 1.4.1 Boundaries 5 1.4.2 Stakeholder Analysis 5 Phase 2: Analysis and Recommendation 7 2 Preliminary Options Analysis 7 2.1 Evaluation Criteria 7 2.2 List the Possible Options 7 2.2.1 The Status Quo 7 2.2.2 Describing the Option 7 2.3 Screening of Options 7 2.4 Rationale for Discounted and Viable Options 7 3 Viable Options 9 3.1 Alignment 9 3.1.1 Strategic Alignment 9 3.1.2 Alignment with Desired Business Outcomes 9 3.2 Costs 9 3.3 Cost-Benefit Analysis 9 3.4 Implementation and Capacity Considerations of Viable Options 9 3.4.1 Contracting and Procurement 9 3.4.2 Schedule and Approach 9 3.4.3 Impact 10 3.4.4 Capacity 10 3.5 Risk 10 3.5.1 Option Risk Summary 10 3.5.2 Risk Register 10 3.6 Benchmark 10 3.7 Policy and Standard Considerations 10 3.8 Advantages and Disadvantages 11 4 Justification and Recommendation 12 4.1 Comparison Summary 12 4.2 The Preferred Option 12 4.2.1 Recommendation 12 4.2.2 Deciding Factors 12 4.2.3 Costs 12 4.2.4 Risks 12 4.2.5 Implementation Plan 12 Phase...
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...Second Order Moment Approach to Real Options Analysis Submitted as a Component of Required Courses for the Award of Bachelor of Engineering (Civil) Honours School of Civil Engineering University of New South Wales Author: Ariel Hersh October 2010 Supervisor: Professor David G. Carmichael i ORIGINALITY STATEMENT ‘I hereby declare that this submission is my own work and to the best of my knowledge it contains no materials previously published or written by another person, or substantial proportions of material which have been accepted for the award of any other degree or diploma at UNSW or any other educational institution, except where due acknowledgement is made in the thesis. Any contribution made to the research by others, with whom I have worked at UNSW or elsewhere, is explicitly acknowledged in the thesis. I also declare that the intellectual content of this thesis is the product of my own work, except to the extent that assistance from others in the project's design and conception or in style, presentation and linguistic expression is acknowledged.’ Signed …………………………………………….............. Date …………………………………………….............. ii 1. ABSTRACT Real options analysis can be used by investors to determine the value of potential investments that offer an owner the right but not the obligation to exercise a strategic decision at a predetermined time and price. Tools which are popular for valuing financial ...
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...4 1.3 Detailed Description of the Business Need 4 4 1.3.1 Problem/Opportunity Statement 4 4 1.3.2 Prioritized Requirements (High Level) 5 4 1.3.3 Assumptions 5 4 1.3.4 Constraints 5 4 1.3.5 Dependencies 5 1.4 Scope 6 4 1.4.1 Boundaries 6 4 1.4.2 Stakeholder Analysis 6 Phase 2: Analysis and Recommendation 7 2 Preliminary Options Analysis 7 2.1 Evaluation Criteria 7 2.2 List the Possible Options 7 4 2.2.1 The Status Quo 7 4 2.2.2 Describing the Option 7 2.3 Screening of Options 7 2.4 Rationale for Discounted and Viable Options 8 4 2.4.1 Advantages and Disadvantages 8 2.5 Alignment 8 4 2.5.1 Strategic Alignment 8 4 2.5.2 Alignment with Desired Business Outcomes 8 2.6 Recommendation 8 Phase 3: Management and Capacity 9 3 Managing the Investment 9 3.1 Governance and Oversight 9 4 3.1.1 Project Management Strategy 9 4 3.1.2 Contracting and Procurement 9 4 3.1.3 Implementation Plan 9 4 3.1.4 Schedule and Approach 9 4 3.1.5 Project Review Strategy 9...
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...Instructor’s Name Course Number 21 July 2012 Investment Management Investment Fundamentals Investment is the process of employing saved money in financial institutions with the hope of gaining returns in the future. Investment management is the process of managing the money employed in financial institutions with the hope of gaining positive returns. The financial institutions are catalogued in a case known as an investment portfolio. An individual with saved money may opt to invest it in financial institutions as a way of adding value to the money. Investing for individuals involves identifying the sources of income for investment such as savings and loans from others. The individual then comes up with investment objectives that will guide his investment decisions. After the funds have been secured, the investor does a market analysis to determine which the best investment opportunities available are for him. A market analysis may be done through a “bottom top” approach or a “top bottom” approach. The “top bottom approach” starts from a macroeconomic level of the market and works downwards towards the different service sectors and industries, finishing with the specific corporate institutions and their portfolio. Once at the corporate level, the investor can decide which investments will afford better returns in the long run (Klammer 36). A competitive analysis is done by the potential investor to determine how his options stand against the other investors. At this stage...
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...Question (11-1): Define each of the following terms: a. Project cash flow; accounting income b. Incremental cash flow; sunk cost; opportunity cost; externality; cannibalization; expansion project; replacement project c. Net operating working capital changes; salvage value d. Stand-alone risk; corporate (within-firm) risk; market (beta) risk e. Sensitivity analysis; scenario analysis; Monte Carlo simulation analysis. f. Risk-adjusted discount rate; project cost of capital g. Decision tree; staged decision-tree analysis; decision node; branch h. Real options; managerial options; strategic options; embedded options i. Investment timing option; growth option; abandonment option; flexibility option a. Project cash flow: The process of inflow or outflow of cash in any project is called cash flow. In project cash flow the increase in income results cash inflow on the other hand, expenditure results cash outflow. Accounting income: Accounting income is the result after deducting the total sales revenue from its expenses. The result of accounting income and cash flow differs in the financial statement because accounting income makes records of both cash and non cash transaction. While in cash flow only pure cash transaction are recorded. b) Incremental cash flow: Incremental cash flow is the additional cash that company may receive by taking a new project. If a company sees positive incremental of cash flow then it means the company can get additional cash flow...
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...systematic appraisal is to achieve better spending decisions for capital and current expenditure on schemes, projects and programmes. This document provides an overview of the main analytical methods and techniques which should be used in the appraisal process. These techniques can also be used in the evaluation process. More detailed information on individual techniques can found in financial and economic textbooks, examples of which are listed at the end of this document and in other guidance material on the VFM portal. An understanding of discounting and Net Present Value (NPV) calculations is fundamental to proper appraisal of projects and programmes. A good understanding of Cost Benefit Analysis (CBA), Internal Rate of Return (IRR), Multi Criteria Analysis (MCA) and Cost Effectiveness Analysis (CEA) is also essential for economic appraisal purposes. 2. Analytical methods The recommended analytical methods for appraisal are generally discounted cash flow techniques which take into account the time value of money. People generally prefer to receive benefits as early as possible while paying costs as late as possible. Costs and benefits occur at different points in the life of the project so the valuation of costs and benefits must take into account the time at which they occur. This concept of time preference is...
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...DECISION MAKING FOR BUSINESS Table of Contents Part A: 2 1.0 Analysis of incremental cost for Fleet Ltd.: 2 2.0 Analysis of the reported profit volume: 2 3.0 Consideration of determining factors in decision making process: 2 4.0 Recommendation: 2 5.0 Executive summary: 2 Part B: 2 1 a) Derivation of cash flows for three available options (amounts in , 000): 2 1 b) Derivation of accounting rate of return for three available options (amounts in , 000): 2 1 c) Derivation of payback periods for three available options (amounts in ,000): 2 1 d) Derivation of Net Present Value for three available options (amounts in ,000): 2 1e) Derivation of internal rate of return for three available options (amounts in , 000): 2 2.0 Appraisal methods and discussion of the recommendation: 2 Bibliography: 2 Part A: 1.0 Analysis of the incremental cost for Fleet Ltd.: The incremental cost analysis of any organization evaluates the changes in organizational effectiveness after incorporating the new strategy for which the cost incurred. Not only that it will also help the organization to find out if it have any other alternatives. In case of Fleet Ltd., there exist three strategies which they incorporated to improve the organization effectiveness. Among those three strategies, the first one involves the changes in the core activities of the organization where as the second activities is mainly concentrating the improvement of the competitive ability of the organization...
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...Running Head: MEMORANDUM Real Option Analysis Memorandum To: CEO From: ABC Date: June 5, 2010 Sub.: Real Option Analysis Introduction In the current competitive and dynamic business environment, it is necessary for an organization to consider all the aspects before making an investment decision in a venture. It is also essential for the management of an organization to perform the analysis of operational facilities and financial facilities in a country. It helps the management to make an effective decision in invest in a venture to expand its business operation. The analysis also helps to reduce some risk that may affect the business operation. Venture The management of the organization is seeking towards facilitating its business in a new uncharted territory. The new venture may be the expansion of current product line or a new product or service. The management of the company is seeking to adjust with the growing demand in Brazil by building a new Caterpillar factory in it. The company doesn’t have information about the operational, financial and capital position in Brazil that may cause an increase in the uncertainties for the business. The organization has a leading position that will be effective tom provide unique advantages to it that is not available for the rivals maintaining purely domestic operations. In the new venture, the management may shift its value chain activities across its operation networks to eliminate the impact of...
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...Guillermo Furniture Store Analysis FIN/571 Guillermo Furniture Store Analysis Kirk B. Carlson FIN/571 Guillermo Furniture Store Analysis Guillermo Furniture Store is located in Senora, Mexico. Guillermo Navallez is the owner and has been successful in business for many years. He manufactures mid quality to high quality furniture at reasonable prices. New competitors have entered Senora, Mexico and are competing for Guillermo Navallez’s customers. As a result of the increase in competition Guillermo Furniture Store’s profit margins have been decreasing. This has forced Guillermo Navallez to re-evaluate his business and make adjustments to stay competitive. Guillermo Navallez needs to weigh his options and pick the best solution for his business. This paper will outline the cost of capital associated with the optimal weighted average, and valuation techniques that can be used by Guillermo Navallez to reduce risk. Options Guillermo Navallez goal is to become a profitable organization and to become a profitable organization he has three options that he needs to consider. The first option is to covert his facility into a high technological facility with the latest manufacturing technology. Guillermo Navallez’s initial cost for the equipment will be high, and he will have to weigh the cost of equipment with the benefits that the equipment will bring to the organization over time. Guillermo Navallez second option is to become a broker for another manufacturing company...
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...provide more efficient use of the client's growing resources, to improve net worth, to reduce income and estate taxes, and to increase after-tax cash flow. A fact-finding session helps us become totally familiar with your current financial situation, as well as your personal goals and priorities. Working from the comprehensive information gathered in the fact-finding session, a detailed financial plan is prepared which documents your current situation, identifies all areas that will be impacted, and makes specific goal-oriented recommendations. Recognizing our ever-changing tax environment, we also work to assure that you are positioned in the most effective manner relative to your personal tax situation. Each recommendation in our analysis is then thoroughly reviewed with you to confirm your understanding and support of each recommendation. If desired, we actively assist in the full implementation of every plan recommendation in conjunction with the other members of your financial advisory team. The following example is a combination of two actual cases that were completed during the 2002 calendar year. The following example provides a realistic example of some of the benefits that a financial plan can provide. Marke & Cher Daler In many financial planning cases, there are one or more variables that have a substantial impact on the results of the analyses. Sometimes these variables are unknown at the...
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...Capital Budgeting Analysis Prepared by: Matt H. Evans, CPA, CMA, CFM This course provides a concise overview of capital budgeting analysis. This course is recommended for 2 hours of Continuing Professional Education. In order to receive credit, you will need to pass a multiple choice exam which is administered over the internet at www.exinfm.com/training A companion toll free course can be accessed by dialing 1-877-689-4097, option 3, ID 752. Chapter 1 The Overall Process Capital Expenditures Whenever we make an expenditure that generates a cash flow benefit for more than one year, this is a capital expenditure. Examples include the purchase of new equipment, expansion of production facilities, buying another company, acquiring new technologies, launching a research & development program, etc., etc., etc. Capital expenditures often involve large cash outlays with major implications on the future values of the company. Additionally, once we commit to making a capital expenditure it is sometimes difficult to backout. Therefore, we need to carefully analyze and evaluate proposed capital expenditures. The Three Stages of Capital Budgeting Analysis Capital Budgeting Analysis is a process of evaluating how we invest in capital assets; i.e. assets that provide cash flow benefits for more than one year. We are trying to answer the following question: Will the future benefits of this project be large enough to justify the investment given the risk involved...
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...Bibliography…………………………………………………………………………………………………10 Executive summary Laura Martin is a reputable equity analyst, who currently deals with the sell-side of equity analysis primarily in the cable industry. Equity analysts are divided into two categories, the buy-side and the sell-side and their main task is to compile financial information of companies along with market information and consult their clients about their investment options. Martin wanted to prove that the stock price of Cox was undervalued because the company was not operating in its full capacity. Martin called the 102 MHz of unused capacity the ‘stealth tier’ as the potential revenue streams from its usage were invisible but not valueless. In order to prove her point Martin used 3 methods: the EBITDA multiple analysis, Discounted Cash flow analysis, and real options Valuation analysis. The main assumptions used for all three methods are; that the revenue growth of the company would accelerate and diversify in the period 1998-2003, that the capital spending would also slow and the nature of investments would change, and that the digital revenue streams would yield higher returns on invested capital. With each analysis Martin tried to forecast the value of Cox stock in the year 2000 by making certain assumptions. With EBITDA multiple analysis and target price of $50, the market capitalization of Cox is increased which in turn increases the implied Cable value, and an EBITDA multiplier of 20.9 times is realized...
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...A problem and decision analysis of the HBR Clayton Industries, Inc. Case | SALIAN.IN Page 1 of 4 SALIAN.IN Having Solemnly Resolved. • Business ◦ Cases • Governance ◦ Rights & Duties • Hobby ◦ Astronomy • Money ◦ Finance • Self ◦ Personal Productivity A problem and decision analysis of the HBR Clayton Industries, Inc. Case Posted by Pranab Salian on 12/29/11 • Categorized as Cases This case is about the challenges faced by Peter Arnell, who has taken over the Italian subsidiary of Clayton Industries, a sixty-year-old U.S.-based firm in the HVAC industry. The short analysis I present is one of many possible readings of this case, and specifically covers existing problems and potential decision options. The case is available from the Harvard Business Review website. Problem Analysis The key business issue facing Clayton in late 2009 is that its Italian subsidiary, Clayton SpA, has been making heavy operational losses for three years now, to the tune of over $1 million USD a month. While these losses have been exacerbated due to a general global recession which has reduced http://www.salian.in/business/cases/problem-decision-analysis-hbr-clayton-industries-case 8/25/2013 A problem and decision analysis of the HBR Clayton Industries, Inc. Case | SALIAN.IN Page 2 of 4 sales (which are down by 19%), their root cause lies in the fact that since 2001, Simonne Buis had been making organizational changes, and trying to create a more integrated European organization...
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...A Meta-Analysis of the Economic Impacts of Climate Change Policy in the United States Adam Rose* and Noah Dormady** This paper provides a meta-analysis of a broad set of recent studies of the economic impacts of climate change mitigation policies. It evaluates the infiuences of the impacts of causal factors, key economic assumptions and macroeconomic linkages on the outcome of these studies. A quantité regression analysis is also performed on the meta sample, to evaluate the robustness of those key factors throughout the full range of macro findings. Results of these analyses suggest that study results are strongly driven by data inputs, economic assumptions and modeling approaches. However, they are sometimes affected in counterintuitive ways. 1. INTRODUCTION The macroeconomic impacts of climate change mitigation policies are controversial among both scholars and the policy-making community. Results range from predictions of severe economic harm to significant overall economic gains. Given the unresolved nature of this debate, this paper seeks to shed light on it by evaluating a wide range of macroeconomic studies through a metaanalytic approach. Meta-analysis is a method for evaluating a cross-section of studies on a given topic, and evaluating the impacts of assumptions, input variables and modeling approaches on the overall findings of the studies. In essence, meta-analysis is a study of studies (Borenstein et al., 2009; Lipsey and Wilson 2001). The Energy...
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