an applied course in real options valuation pdf

Furthermore, the option to abandon a project is important and valuable in research and development (R&D) investments as it provides the flexibility to abandon a project in the presence of negative outcomes. On the other hand, even with a positive NPV project, the option to delay the investment is valuable as it gives the firm the opportunity to wait until more market information is available. In this case, the option to expand is valuable and must be considered when quantifying the value of the mine. This investment will provide the option to develop the remainder of the mine when and if market prices change. Consider the valuation of a mine of which, at current commodity prices, only half is economically feasible for development. For example, the option to expand a project is valuable when a firm may want to invest in a negative net present value (NPV) project if it provides the firm the possibility of developing a new project. There are four main types of options associated with investment projects-the option to expand, to postpone, to abandon, and to temporarily suspend an investment. Most investments are subject to options valuation. Whenever possible, real options valuations are aligned with financial market valuations. Uncertainty and the agent's ability to respond to it (flexibility) are the source of value of an option. Options are contingent decisions that provide the opportunity to make a decision after uncertainty unfolds. The real options approach is an extension of financial options theory to options on real/non-financial assets. Two applications of the real options approach are discussed in more detail: the valuation of natural resource investments and the valuation of research and development investments. Recent developments in the valuation of complex American options has allowed progress in the solution of many interesting real option problems. After a general introduction to the subject, numerical procedures to value real options are discussed. Email: paper provides an overview of the real options approach to valuation mainly from the point of view of the author who has worked in this area for over 30 years. ** California Chair in Real Estate and Land Economics Professor of Finance, Anderson School of Management, University of California, Los Angeles.

Hay Jin Kim provided valuable assistance. * This lecture was delivered at the 2013 Finance UC Conference in Santiago, Chile. THE REAL OPTIONS APPROACH TO VALUATION: CHALLENGES AND OPPORTUNITIES *

An applied course in real options valuation pdf