INSEAD Library

Includes bibliographical references and index

Digitized

An Applied Course in Real Options Valuation Table of Contents Preface and User's Guide xiv Part 1 Motivation 1. Introduction 1.1 Theory Versus Practice 1.2 Two Important Concepts 1.3 Examples of Managers Investing When the Static NPV Is Negative 1.4 Examples of Managers Doing Nothing When the Static NPV Is Positive 1.5 A 50,000-Foot Flyover of Chapters 2 and 3 1.6 Why DCF Is Static 1.7 Chapter Summary 1.8 Bibliography 18 22 27 30 31 5 1 3 3 Part 2 The Theory of Value 2. Valuation of Financial Assets 2.1 Arbitrage and Arbitrage Opportunities 2.2 Our Model Economy 2.3 Valuation by Arbitrage in Our Model Economy 2.4 Valuation of the Index Option (Advanced) 2.5 Summary 2.6 Bibliography Appendix 2.1 Solving for the Tracking Portfolio Holdings 90 81 88 89 58 40 41 44 Appendix 2.2 The Single-Period CAPM in Our Economy 3. Valuation of Real Assets: What Corporate Finance is All About 3.1 Our Model of the World 3.2 Evaluating a Static Growth Opportunity at the Consulting Firm 3.3 A Delayed Growth Opportunity 3.4 When Do Investors Want Managers to Maximize NPV? 3.5 Two Misconceptions and Why They Are Wrong 3.6 Summary 3.7 Bibliography and Suggested Reading Appendix 3.1 The Underlying Asset and the MAD Assumption (Advanced) Appendix 3.2 Solving for the Tracking Portfolio Holdings 135 132 126 129 131 131 114 121 104 105 93 Part 3 The Binomial Model 4. Modeling Uncertainty and Valuing Flexibility 4.1 How a Binomial Model Approximates a Normal Distribution 4.2 Valuation by Arbitrage and Linear Pricing in the Single-Step Binomial Model 4.3 The Amazing Theory of Risk-Neutral Pricing 4.4 Three Simplified Real-World Examples 4.5 Multistep Binomial Trees 4.6 How to Build Recombinant Binomial Trees 4.7 A Binomial Tree Example 4.8 Bibliography Appendix 4.1 An Alternative Approach to Binomial Trees 248 158 180 198 216 228 238 248 149 146 Appendix 4.2 Another Alternative Approach (This One with Simple Discounting) Appendix 4.3 249 252 Part 4 European-Style Real Options 5. Research and Development: Valuing the Preliminary Design of a Super-Jumbo Jet at Boeing 5.1 Background: Strategic Thinking and Strategic Investment 5.2 Why the Super-Jumbo-Jet Concept Displayed Negative Static NPV 5.3 The Static NPV of the Investment in Preliminary RECD 5.4 Creation of a Strategy = Creation of an Option 5.5 Valuing the Option 5.6 Postscript 5.7 Two Important Final Points 5.8 Bibliography 6. Platform Investments: A Lesson on Volatility Estimation 6.1 The Problem for This Chapter: A Platform Investment 6.2 A Way to Calibrate the Volatility Parameter 6.3 Break-Even Volatility 6.4 A Word of Caution 6.5 An Added Difficulty 6.6 Summary 7. Multistage Investment: The Phased Rollout of Wal-Mart Neighborhood Markets 7.1 Some Background--The Supermarket Industry 7.2 Option Valuation 306 307 312 289 297 300 301 302 302 287 267 269 280 282 283 266 263 262 262 8. Early-Stage Pharmaceutical REandD: The Interaction of Market and Technical Risk 8.1 Market Risk and Technical Risk 8.2 Static NPV 8.3 Framing and Analyzing the Problem, Assuming No Technical Risk 8.4 How to Deal with Technical Risk in the REID Process 8.5 Valuation of Our REID Investment with Technical Risk 8.6 Summary 8.7 Bibliography 347 353 354 342 332 324 325 328 Part 5 American-Style Real Options 9. Introduction to American Options 9.1 Our Basic Binomial Model--A Review 9.2 Storage Costs on Assets Held for Investment Purposes 9.3 Known Cash Income from Assets Held for Investment Purposes 9.4 Storage Costs and Known Cash Income on Assets Held for Production 9.5 Yet Another Way to Think About Cash Yield or Convenience Yield 9.6 How to Handle Net Convenience Yield in the Binomial Model 9.7 Convenience Yield in Corporate Growth Options with Early Exercise Flexibility 10. Valuation and Optimal Development of a Coal Mine 10.1 Introduction and Background 10.2 Our Problem: An Option on a Coal Mine 10.3 A Brief, But Important, Final Observation 373 375 376 377 387 370 369 367 361 359 358 358 11. When Do You Abandon a Money-Losing Business? An American Option with Foreign Currency Risk 11.1 Historical Background 11.2 Mead Johnson 11.3 Modeling Uncertainty 11.4 Option Analysis 11.5 Comparative Statics 11.6 References 12. Value Erosion as Convenience Yield: The Incredible Shrinking Oil Well 12.1 Background 12.2 Our Problem 12.3 Modeling the Uncertainty in the Value of the Shrinking Well 12.4 Valuing the American Option on the Shrinking Well 12.5 Comparative Statics 12.6 The Grand Lesson Appendix 12.1 13. Convenience Yield as Shrinkage in the Underlying: Valuation of a Tax Credit Investment at Koch Industries 13.1 Background 13.2 Koch's Investment Opportunity 13.3 The Option Analysis 14. Delayed Response to Exercise: Fab Shells at Intel 14.1 A Very Simple Example 14.2 The Fab Shell at Intel 14.3 Valuation and Evaluation When There's Delay 459 428 428 430 432 444 446 451 421 424 425 425 416 391 391 392 395 397 407 410 413 414 414 14.4 Bibliography Appendix 14.1 15. Multiple Choices: Evaluation of Optimal Pollution Compliance Strategy 15.1 Georgia Power's Plant Bowen 15.2 Static Cost Minimization Analysis 15.3 Option Analysis 15.4 What Happened? 15.5 Bibliography Appendix 15.1 470 470 476 478 479 483 495 496 496 Part 6 Conclusion 16. What Else Can You Do? 16.1 The Binomial Solution Technique 16.2 Other Lattice Models 16.3 Monte Carlo Simulation 16.4 A Few Final Words 16.5 Bibliography Index 506 506 508 510 512 513 515