Literature review Real option valuation calls for an elaborate and a firm strategy to form a conceptual tool to make the decision for the company (Kim & Sanders 2002). The most appropriate tool to be used in uncertainty cases is using real option as a technique to assess investments for contexts with high market, technical and technological uncertainty (Billington, Johnson & Triantis 2002). This is because they allow managerial flexibility and option analogy. Real options ensure delaying making a right decision on investment of a company until a time when the right information is obtained to make the best decision. Kim & Sanders (2002) notes that real option approach in this case takes into consideration ascertaining important sources of ambiguity and distinguishing, making, and fostering options whose values comes from responding to new information about the uncertainties. Mun (2002) notes that real options are important in identifying taxonomy of the business. Real options are more important in growth options of the business since they are analogous to financial call options. Longstaff & Schwartz (2001) notes that, real options involve a sequence of investment over a period that makes them preferable than the other capital budgeting decisions. These real growth options thus compound options, where options are formed upon the exercise of previous options. Moreover, real options are better used as techniques to assess investments for contexts with high market, technical and technological uncertainty since they allow companies to make decisions on contracting situations. This can have a significant impact on the value of the shareholder (Li & Johnson 2002). Value Drivers of Real Options Kim & Sanders (2002) notes that value created from the right and not the obligation to acquire or exchange a specific asset, has value even though not ad infinitum. Option value determined by several factors, both quantitative and qualitative. Understanding the above factors enables managers to make the appropriate decisions in order to exploit them. Uncertainty about the future Real options are determined by uncertainty about the future. This implies that if more possibilities of interacting with the uncertainties exist, then they will create value. This situation is created by asymmetric payoff structure alongside discretionary rights. Time to expiration Real options are also determined by the time to expiration. This situation implies that the more time an option takes to exercise the option, the more valuable the option will become. The reason behind this rationale is that the lengthy time will work to increase uncertainty. However, in other cases, increases in uncertainty are often offset by increased in costs, which are triggered by the lengthy period (Li & Johnson 2002). Time value of money Real options are also affected by the time value of money. This is an essential part since money affects all the sectors of the economy. Monetary policies by the government affect all sectors of the economy and have impacts on investment decisions, which concern undertaking or abandoning the project. Time value of money affects inflation, cost of capital, and macroeconomic stability, which in turn affects real options. The reason behind this is that the interest rate charged by the central banks affects the time value of money, thus exposing real options to political risks. Qualitative factors Real options are
Investment Appraisal under Uncertainty 4th December 2012 Capital budgeting decisions Real option valuation Real option valuation is a form of capital budgeting techniques that applies option valuation technique to value the future worth of an investment portfolio…
The system should be in charge of human resource plans, policies, procedures, and best practices. The attributes are interconnected and together they shape the foundation of an organization’s capacity to perform. The effectiveness and quality of the set decisions determines how successful a manager or organization will be.
The main character, Erin, is a woman who, with three children and not being employed, has an accident and loses the case that her lawyer had assured her she was going to win. When this happens, she gets her lawyer to employ her at his firm and she gets to encounter the pro-bono case that is eventually going to put her in the limelight.
However, it entails evaluating the available options through a certain criteria (Wang & Ruhe, 2007, p. 83). History has it that every person has to make choices for him or her survival. Human beings are socialized to analyze and make the decision that would in to him the most beneficial.
Some had been reluctant in their past performances, but today, they stand out for being very organized and profitable. Tables have turned; companies and their management have to adjust with the economic and technological changes, to reinforce their decision making.
The traditional capital budgeting decision model used is discounted cash flow (DCF). Such an analysis is linear and static in nature and assumes the investment opportunity is not totally reversible or is a now-or-never opportunity. It also implicitly assumes net present value (NPV) positive projects exist only when firms can exploit temporary competitive advantages and governments do not exist or are neutral (Myers 147-175; Luehrman 145-154).
In other words, the system of capital budgeting is employed to evaluate expenditure decisions which involve current outlays but are likely to produce benefits over a period of time longer than one year.
This essay focuses on investment appraisal as a form of management control. Initially the meaning of investment and various types of investments are discussed, followed by arguments explaining the need for
But according to the authors, DCF procedures can work if the management sets realistic hurdle rates, and carefully examines its assumptions. Decision makers need to consider three critical issues: the effects of inflation, the different levels of uncertainty in
The company uses the straight-line method to depreciate assets and estimates its cost of capital at 18%. Because of capital rationing, only one project can be accepted. To calculate depreciation expense on a fixed asset with a salvage value, the depreciable value of the fixed asset is divided by the life of that asset.
Corporate decisions today can only be made when a set of alternative strategies on investments are obtained.
Real option valuation calls for an elaborate and a firm strategy to form a conceptual tool to make the decision for
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