Real Options Analysis Flashcards
(10 cards)
What is a Real Option?
A right, not obligation, to act on a non-financial asset at a predetermined cost on or before a predetermined date
What is a financial option?
A type of derivative contract that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specified strike price, on or before a specified date.
- A call option - right to buy asset
- A put option - right to sell asset (called a naked put if you do not own! You have to buy, then sell the asset)
Who is the option holder?
The entity who has the decision power
What is the option price with an example?
The cost to create/keep the option (e.g. the cost of a feasibility study)
What is the strike price?
The cost to implement the new scenario
When is an option in the money?
When the value > cost of execution
What Real Options do you have for projects?
What do real options do?
- They transfer risk and allow you to profit from uncertainty.
They add value through flexibility in the face of uncertainty.
What is Net Present Value (NPV)?
Sum of all future project cash flows, discounted back to today’s value, minus the initial investment cost.
NPV > 0 - project adds value
NPV < 0 project destroys value
NPV = 0 project breaks even
Why does real options analysis (ROA) complement NPV with an example?
Think about your profit and loss model for the temporary arena project
- ROA enhances NPV by valuing adaptabilty to project decisions over time.
- Provides upside potential and downside protection under uncertainty.
- For example, profit and loss with economic entity retained vs profit and loss with economic entity removed?
