Corporate Finance
Real Options
A real option measures decision flexibility attached to a real asset: delay, expand, contract, abandon or invest in stages as information changes.
Course purpose
The decision examined
A static NPV may assume an immediate commitment to a fixed path. Flexibility can matter when management can act after observing demand, cost or feasibility, but waiting may sacrifice cash flows or exclusivity.
Objectives
Learning outcomes
- Identify flexibility that changes future cash flows.
- Distinguish delay, expansion, contraction and abandonment.
- Compare option value with the cost of preserving flexibility.
Concepts
Key concepts
- Deferral
- Abandonment
- Expansion
- Staged investment
- Continuation value
- Exercise
Syllabus
Course structure
- Static NPV limit
- Option analogy
- Deferral
- Expansion
- Abandonment
- Sequential investment
Extract
Analytical framework
Decide at the exercise date
When exit is possible at date t, the company compares continuation with the net proceeds from stopping:
Value at the decision date
The comparison includes closure costs, taxation, contractual commitments and recovery timing. Gross resale value alone is insufficient.
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