Real Options: Tropical Sweets Inc - Article Example

Mini Case: Real Options-Tropical Sweets Inc. Mini Case: Real Options-Tropical Sweets Inc. b. Executive Summary The mini case of Tropical Sweets Inc. is largely concerned with the issue of real options evaluation including familiarizing the corporate executives of the company on the types of real options, potential procedures for analyzing real options and the related calculations. In corporate finance, a real option refers to the available choices or alternatives in a business investment opportunity which may present an investor with two different investment choices to choose from and where both of the investment choices involve tangible assets. For example, in a real investment, the company or individual investor is normally presented with the choice between assets like inventory or land (Brigham and Daves, 2012). Generally, these options are particularly considered to be real because they are usually associated with tangible assets such as capital equipment as opposed to financial instruments. In this regard, the real options include the opportunities available for the business to expand and finish projects if particular conditions arise among other options available. On the other hand, financial instruments such as bonds or stocks may not be included in real options. Consideration of the real options in in the financial analysis of a company can significantly impact on the valuation of various potential investments. However, some valuation methods like NPV do not usually include the important benefits that are provided by real options. c. Financial Theory Relevant to the Case One of the financial theories most relevant to the above case is the real options theory. According to Martha and Nalin (2006), the real options theory is a critically important new frame work that is increasingly being used in making various investment decisions. The theory particularly modifies the traditional Expect Net Present Value theory that has been commonly applied in investment decisions. According to the real options theory, some of the possible procedures that can effectively be incorporated in the analysis of real options include decision tree analysis, DCF analysis of cash flows and modeling of the available financial options. However, many of the previous theories like the NPV theory do not offer any provision in investments decisions related to projects and this may significantly undervalued the potential benefits of the particular projects. The real Options theory is closely related to the decision tree analysis and Richard Bellmans Dynamic Programming. In addition, the theory offers important additional insights on the formal perspectives of evaluation of the optimal sequential decision-making tools. Based on this theoretical perspective, the consideration of the real options in in the financial analysis of a company like Tropical Sweets Inc. is critically important as it can significantly impact on the valuation of various potential investments (Brigham and Daves, 2012). This is particularly attributed to the numerous potential benefits that are provided by real options In the above mini case of Tropical Sweets Inc., the real options theory is critically important as it can provide the important perspective of evaluation of the available choices or alternatives in a business investment opportunity which may present an investor with two different investment choices to choose from and where both of the investment choices involve tangible assets. f. WSJ News Article Trigeorgis, L.T., Brosch, R., Smit, J.T. (2007, September 15). Business Insight Strategy: Stay Loose. The Wall Street Journal, pp. R4. Retrieved on November 1, 2015 from http://www.wsj.com/articles/SB118841806712612518 The Wall Street Journal article titled “Stay loose” is primarily based on the argument that proper business planning requires real options analysis as it gives the business managers and executives the right rather than the obligation to pursue some business initiatives at particular prices at some given time in the future, thereby improving the potential outcomes of the business investment. This may particularly involve carrying out a comprehensive analysis of the various available choices or alternatives in a business investment opportunity which may present an investor with two different investment choices to choose from and where both of the investment choices involve tangible assets. According to Trigeorgis, Brosch and Smit (2007), good business managers are usually able to think on their feet. The researchers argue that many of the contemporary tools of business strategy development that are currently being used are primarily designed for stable environments and this may lock many business managers into making business decisions that may eventually turn out to be flawed whenever something outside the control of the manager has not gone as planned. This problem calls for the need for real options analysis that may include undertaking some form of systematic translation of the flexibility of the managers into a plan or strategy or plan that provides different options for the manager thereby presenting them with a choice to pursue of drop certain business development strategies based on their potential benefits and limitations. The authors suggest also that this may significantly help the executives to enhance and incorporate flexibility in their business plans. On the other hand, with regard to the development of business competitive advantages, the article argues that real options analysis offers one of the most useful tools of addressing business challenges and competition to the strategic managers in order to help them to be able to effectively analyze and predict how competition can play out and how they can enhance their flexibility. g. Summary and Conclusion In conclusion, real options is critically important in corporate financial analysis as it helps enhance the effectiveness of the company decision making particularly in situations where the business environment may be characterized by management flexibility and uncertainty in responding to particular investment needs. For example, real option analysis (ROA) is primarily concerned with the available choices or alternatives in a business investment opportunity in order to provide an investor with different investment options or choices to choose from and where both of the investment choices involve tangible assets such as land or capital equipment rather than financial instruments. This particularly contrasts with some of the available approaches in business investment decision making such as Net Present Value (NPV) approach many of which do not offer any provision in investments decisions related to projects and this may significantly undervalued the potential benefits of the particular projects. This is likely to be attributed to the fact that the business investment decision making like Net Present Value (NPV) approach assumes that investment opportunity is involves a rigid now or never form of decision, whereby a decision that has been undertaken does not present any further option for the managers to change course. According to the real options theory, the real options analysis provides all the opportunities available for the business to expand and finish projects if particular conditions arise among other options available. Generally, the real options theory is a critically important new frame work that is increasingly being used in making various investment decisions. The theory particularly modifies the traditional Expect Net Present Value theory that has been commonly applied in investment decisions. Consequently, incorporating the real options in in the financial analysis of a company can help in the valuation of various potential investments. References Brigham, E., Daves, P. (2012). Intermediate financial management. Mason, OH: South-Western Cengage Publishing. Martha A., Nalin K. (2006). Real Options: Managerial Flexibility and Strategy in Resource Allocation. Cambridge, MA: MIT Press. Read More