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Handout Problem Set 7 - Lehrstuhl für Controlling
Technische Universität München Value-Based Management Handout Problem Set 7 Valuing and Managing Real Options Lehrstuhl für Controlling Prof. Dr. Gunther Friedl Email for questions and comments: [email protected] Technische Universität München Question 13: Residual income and the option to wait t=0 t=1 invest b =110 in P1 t=2 cash flow c1 =165 invest b in P2 c2H=242 c2L=0 not invest not invest Manager privately knows c1 and has expectations about c2 cash flow c2 (c2H, c2L) no cash flow Manager learns c2 Thus, in t = 0 the manager has the possibility either to invest in the first year project P1 or not to invest and wait until t = 1. If he invests b = 110 in P1, the investment will yield a certain cash flow of c1 = 165 in t = 1. If the manager decides not to invest in t = 0, he will learn in t = 1 whether an investment in P2 will yield the cash flow c2H or c2L. As he is not bound to invest in P2, he has the option not to invest if the investment would be unprofitable, that is, when c2 = c2L. Handout Problem Set 7: Option to Wait 2 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Setting Suppose a risk-neutral firm has the opportunity to invest a fixed budget of b = 110 into one out of two mutually exclusive investment projects. The investment opportunities occur sequentially within a two-period planning horizon. The first project, P1, is available at the beginning of the planning horizon (t = 0). It yields a certain cash flow of c1 = 165 at date t = 1. Instead of investing the money right away, the firm can also refuse P1, wait one period, and invest the same amount into a second project, P2, at date t = 1, which yields a cash flow in t = 2. Waiting to invest in P2 is risky. At t = 0, the firm only knows the probability distribution of the cash returns of P2. The cash flows of project P2 equal c2H = 242 with probability p or c2L = 0 with probability (1 – p). At the end of the first period, i.e., after eventually refusing P1 but before deciding on the implementation of P2, the firm learns the project’s cash returns Handout Problem Set 7: Option to Wait 3 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Optimal decision from the firm’s point of view Handout Problem Set 7: Option to Wait 4 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Optimal decision from the firm’s point of view Handout Problem Set 7: Option to Wait 5 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Optimal decision from the firm’s point of view Handout Problem Set 7: Option to Wait 6 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Decision of the manager if the value of the option to wait is not capitalized Handout Problem Set 7: Option to Wait 7 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Decision of the manager if the value of the option to wait is not capitalized Handout Problem Set 7: Option to Wait 8 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Decision of the manager if the value of the option to wait is not capitalized Handout Problem Set 7: Option to Wait 9 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Decision of the manager if the value of the option to wait is capitalized Handout Problem Set 7: Option to Wait 10 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Decision of the manager if the value of the option to wait is capitalized 1) Investment in P1 t=0 t=1 Book valuet Depreciationt Inct = ct depreciationt RIt = Incomet – r∙ book valuet-1 Handout Problem Set 7: Option to Wait 11 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Decision of the manager if the value of the option to wait is capitalized 2) Wait and invest in P2 t=0 t=1 t=2 Book valuet Depreciationt Inct = ct depreciationt RIt = Incomet – r∙ book valuet-1 Handout Problem Set 7: Option to Wait 12 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Decision of the manager if the value of the option to wait is capitalized 3) Wait and not invest at all t=0 t=1 t=2 Book valuet Depreciationt Inct = ct depreciationt RIt = Incomet – r∙ book valuet-1 Handout Problem Set 7: Option to Wait 13 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Handout Problem Set 7: Option to Wait 14 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Handout Problem Set 7: Option to Wait 15 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Handout Problem Set 7: Option to Wait 16 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Handout Problem Set 7: Option to Wait 17 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Handout Problem Set 7: Option to Wait 18 Prof. Dr. Gunther Friedl – SS 2016 Technische Universität München Question 13: Residual income and the option to wait Handout Problem Set 7: Option to Wait 19 Prof. Dr. Gunther Friedl – SS 2016
