Venture
LECTURE 4
Investment under uncertainty, real options
Derivatives valuation approach. Example:
Copper mine
Strategic options. Examples:
Copper mine with shutdown option
Valuing Vacant Land
Valuation of an option to delay
Ratio comparison approach
Additional Definitions
ECOM051 Business Finance, Lecture 4 (Dr Giles Spungin, G.Spungin@qmul.ac.uk, www.excalibur24.com, QMUL©2010-11)
1
Discounted cash flow methods ignore opportunities (strategic options, indirect cash flows) created by investment project. Strategic options exist whenever management has any flexibility regarding the implementation of a project. Options to change the scale of a project (downsize, expand), abandon it, or drastically change its implementation in the future are examples of strategic options. The existence of these options improves the value of an investment project and as such should be reflected on the price
/ investment cost.
Alternative methods of valuing such projects, with an additional advantage of yielding more accurate estimates of future cash flows are given by:
Derivatives valuation approach (copper mine examples)
Strategic options (vacant land and option to delay examples)
Ratio comparison approach
ECOM051 Business Finance, Lecture 4 (Dr Giles Spungin, G.Spungin@qmul.ac.uk, www.excalibur24.com, QMUL©2010-11)
2
Sources of positive NPV
There might be several sources of competitive advantage:
Barriers to entry
Economies of scale
Economies of scope
Derivatives valuation approach
DEFINITION: Financial derivative is a financial asset value of which is determined by some other underlying asset. For example, stock option’s value is determined by the price of the underlying stock.
DEFINITION: Call (put) option on a stock is a financial asset giving its owner right to buy (sell) an underlying stock at a given stock price and predetermined date. The owner can either
Investment under uncertainty, real options
Derivatives valuation approach. Example:
Copper mine
Strategic options. Examples:
Copper mine with shutdown option
Valuing Vacant Land
Valuation of an option to delay
Ratio comparison approach
Additional Definitions
ECOM051 Business Finance, Lecture 4 (Dr Giles Spungin, G.Spungin@qmul.ac.uk, www.excalibur24.com, QMUL©2010-11)
1
Discounted cash flow methods ignore opportunities (strategic options, indirect cash flows) created by investment project. Strategic options exist whenever management has any flexibility regarding the implementation of a project. Options to change the scale of a project (downsize, expand), abandon it, or drastically change its implementation in the future are examples of strategic options. The existence of these options improves the value of an investment project and as such should be reflected on the price
/ investment cost.
Alternative methods of valuing such projects, with an additional advantage of yielding more accurate estimates of future cash flows are given by:
Derivatives valuation approach (copper mine examples)
Strategic options (vacant land and option to delay examples)
Ratio comparison approach
ECOM051 Business Finance, Lecture 4 (Dr Giles Spungin, G.Spungin@qmul.ac.uk, www.excalibur24.com, QMUL©2010-11)
2
Sources of positive NPV
There might be several sources of competitive advantage:
Barriers to entry
Economies of scale
Economies of scope
Derivatives valuation approach
DEFINITION: Financial derivative is a financial asset value of which is determined by some other underlying asset. For example, stock option’s value is determined by the price of the underlying stock.
DEFINITION: Call (put) option on a stock is a financial asset giving its owner right to buy (sell) an underlying stock at a given stock price and predetermined date. The owner can either