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Evaluation Of Investment Projects Using Real Options

Evaluation Of Investment Projects Using Real Options Investment projects are typically based on an analysis of expected cash flows and discount rates prevailing for the moment of the analysis, so the net present value calculated on this basis are considered a measure of the value of the project and its acceptability at the moment.

In fact, both the cash flows and discount rates can change during the life of the project, and therefore the net present value of the project changed. The project, which is the net present value calculated now is negative, it could become a net present value of the future is positive. In a competitive environment where he does not have any competitive advantage to its competitors in the explicit acquisition of possible Rubix Project Trading Foundation, it may not be so no matter how much.

Rubix Project
Rubix Project

But if the nature of the investment project requires that acquires him one institution (due to legislation or judicial obstacles that prevent the entry of competitors), it is different, as the change in the value of the project over time makes the project properties held an option to buy.

Let’s explain the idea of ​​the project value relationship over time and purchase options:

Let’s assume that a particular project requires an initial investment value of (), and that the expected present value of the project cash flows and which have been calculated now equal to (), namely:

In this case, the net present value of the project:

Now suppose that a certain company has the exclusive right to this project for two (years), and that the net present value of the project could change during this period, due to changes in both the cash flows and the discount rate.

Can, upon the above-be for the project’s net present value is negative, but can at the same time that the project becomes profitable if the institution waited some this case, will rule that the institution’s decision to control the project as follows:

if it was:

$ 1 · (): The Foundation accepts project: The project has a positive net present value
$ 1 · (): the institution rejects the project: the net present value of the project is negative
In the case of non-acceptance of the project, it will not result in any additional cash flows, while the company will lose the value of the investment relationship just like what is happening in purchase options Options -as explained above-option buyer compares the price of the underlying place of contracting ( current price) and the exercise price specified in the contract. If the exercise price lower than the current price, do his option to purchase, which buy the asset. In the opposite case, he will relinquish his choice and lose the value of the premium (initial investment).

4.3 – the option of postponing the project:

Deferral option -as already defined-is the possibility of postponing the investment project, the decision to allow the availability of new information reduces the uncertainty of some variables, and calculate the value of the deferral option, we need some input, which is the same used for the pricing of any option (the original value of the place of contracting and the varying value , the date to the end of the option maturity, the exercise price, risk-free interest and the cost deferral rate, which is equivalent in this case the average income Rubix Project Brian Morgan application on the ground, the estimation of these inputs especially those related innovative products (patent) is not easy. the following determine inputs going deferral option:

$ 1 value of the asset place of contracting: Original place of contracting is the same investment project. The current price of the asset is the present value of expected cash flows generated by the project (and of course, include the initial cost of the project). And cash flows of the project are estimated normally using budget is the uncertainty of the cash flows of the project, accounting for, but which is why the delay (postpone) the project worthwhile, even if the expected cash flows sure of, and facing the possibility of change, there would have been no need options.
$ 1 fluctuation (variation) originally contracted price shop: The volatility of the cash flows of the project and thus replaces the original contract price is the one who makes the real value of the options. The value of the option depends postponement heavily on cash flow variation (positive correlation)
You can estimate the fluctuation of the current value of the cash flows of the project through one of the following methods:

$ 1ü can be guided by similar projects within the company itself in the case of its presence. For example, a company can estimate the expected pastures announced the launch of a new product from the cheese out of a subdivision of existing manufacturing cheeses cash flow variation.
$ 1ü can customize the likelihood of a wide range of possible scenarios in the market, and the estimate of cash flows under each scenario, and estimate the volatility of the current values.
$ 1ü account the fluctuation of the value of the Tesler Investment company for a group of companies that operate in the same sector. For example: the average variation value of the company for the cement sector companies can be considered as the fluctuation of the current value of the project in the cement.
$ 1 Slippage: performs the postponement of a particular project only if the company owning the rights to the project decided to implement the project in which any investment option, and represents the cost of entry in the project execution price. And assumptions that should be referred to here, is that this cost (the exercise price) remains constant, and any fluctuation should be reflected only in the expected cash flows of the project.
$ 1 shelf life option: the delay of the project option expires as soon as the right company in the project. It is therefore assumed that the net present value of the project is zero, where the competition leads to equal the rate of return on the project is equal to or less than the required rate.
$ 1-free interest rate risk: Empty the interest rate risk of the user in the option must comply with a period of validity of the option. While this price is estimated easy in the case of the company owning the exclusive rights for the project (through license or owning a patent), it is very difficult in the case of the presence of competitors, even if the company acquired a competitive advantage compared to competitors to win the project.