Examples Real Options Chapter 810

1
Examples Real Options(Chapter 8-10)
2
Flexibility Real Options

• Decision Trees - Diagram of sequential decisions
  and possible outcomes.
• Decision trees help companies determine their
  Options by showing the various choices and
  outcomes.
• The Option to avoid a loss or produce extra
  profit has value.
• The ability to create an Option thus has value
  that can be bought or sold.

3
Decision Trees
Success
Test (Invest 200,000)
Pursue project NPV2million
Failure
Stop project NPV0
Dont test
NPV0
4
Decision Trees(Magna Charta)
960 (.8) 220(.2) 930(.4) 140(.6) 800(.8) 100(.2) 4
10(.8) 180(.2) 220(.4) 100(.6)
150(.6) 30(.4)
-550 NPV ?
Turboprop
-150
100(.6) 50(.4)
or
0
-250 NPV ?
Piston
5
Decision Trees (Magna Charta)
960 (.8) 220(.2) 930(.4) 140(.6) 800(.8) 100(.2) 4
10(.8) 180(.2) 220(.4) 100(.6)
812 456 660 364 148
150(.6) 30(.4)
-550 NPV ?
Turboprop
-150
100(.6) 50(.4)
or
0
-250 NPV ?
Piston
6
Decision Trees (Magna Charta)
960 (.8) 220(.2) 930(.4) 140(.6) 800(.8) 100(.2) 4
10(.8) 180(.2) 220(.4) 100(.6)
812 456 660 364 148
150(.6) 30(.4)
-550 NPV ?
Turboprop
-150
100(.6) 50(.4)
or
0
-250 NPV ?
Piston
7
Decision Trees (Magna Charta)
960 (.8) 220(.2) 930(.4) 140(.6) 800(.8) 100(.2) 4
10(.8) 180(.2) 220(.4) 100(.6)
812 456 660 364 148
150(.6) 30(.4)
-550 NPV ?
Turboprop
450
-150
or
100(.6) 50(.4)
0
331
-250 NPV ?
Piston
8
Decision Trees (Magna Charta)
960 (.8) 220(.2) 930(.4) 140(.6) 800(.8) 100(.2) 4
10(.8) 180(.2) 220(.4) 100(.6)
NPV888.18
812 456 660 364 148
150(.6) 30(.4)
-550 NPV ?
NPV444.55
Turboprop
450
-150
NPV550.00
or
100(.6) 50(.4)
0
331
-250 NPV ?
NPV184.55
Piston
9
Decision Trees (Magna Charta)
960 (.8) 220(.2) 930(.4) 140(.6) 800(.8) 100(.2) 4
10(.8) 180(.2) 220(.4) 100(.6)
NPV888.18
812 456 660 364 148
150(.6) 710.73 30(.4)
-550 NPV ?
NPV444.55
Turboprop
450
-150
NPV550.00
100(.6) 403.82 50(.4)
or
0
331
-250 NPV ?
NPV184.55
Piston
10
Decision Trees (Magna Charta)
960 (.8) 220(.2) 930(.4) 140(.6) 800(.8) 100(.2) 4
10(.8) 180(.2) 220(.4) 100(.6)
NPV888.18
812 456 660 364 148
150(.6) 710.73 30(.4)
Turboprop
-550 NPV96.12
NPV444.55
450
-150
NPV550.00
100(.6) 403.82 50(.4)
or
0
Piston
331
-250 NPV117.00
NPV184.55
11
Decision Trees (Magna Charta)
960 (.8) 220(.2) 930(.4) 140(.6) 800(.8) 100(.2) 4
10(.8) 180(.2) 220(.4) 100(.6)
NPV888.18
150(.6) 710.73 30(.4)
812 456 660 364 148
Turboprop
-550 NPV96.12
NPV444.55
450
-150
NPV550.00
100(.6) 403.82 50(.4)
or
Piston
331
0
-250 NPV117.10
NPV184.55
12
Decision Trees (Magna Charta)
Net Present Value Calculation without any option
13
Decision Trees (Magna Charta)
Net Present Value Calculation without any option
14
Decision Trees (Magna Charta)Option to Expand
In case, Agnes has invested in the Piston plane,
she will have to decide whether to expand or not
in t1
Agnes will invest !!