FINM3411: REAL OPTIONS

real options

The right but not the obligation to undertake a future business initiative such as expanding, deferring, abandoning a project.

squares and circles DECISION TREE ANALYSIS

• Squares --> decisions you make

• Circles --> indicating uncertainty that is out of control of the decision maker

HOW TO SOLVE TREE ANALYSIS (WORK BACKWARDS)

1. Look at the end of the tree --> see how much money happens in each case

2. Move backwards to the circle --> take the average using probabilities

3. Move backwards to the square --> pick the choice that gives more money

• it will take 2 years to construct the plant 

• Cost = 100m

• Cash flow = 25m

• Growth = 0.03

• Cost of capital = 0.15

• Tax = 0.3

• Volatility = 0.3

• Rf= 0.04

what is the most that u would pay if u delayed construction by 2 years