Valuation: Packet 3
Real Options, Acquisition Valuation
and Value Enhancement"
Updated: January 2012
Real Options: Fact and Fantasy"
Underlying Theme: Searching for an Elusive Premium"
Traditional discounted cashflow models under estimate the value of
investments, where there are options embedded in the investments to
• Delay or defer making the investment (delay)
• Adjust or alter production schedules as price changes (flexibility)
• Expand into new markets or products at later stages in the process, based upon
observing favorable outcomes at the early stages (expansion)
• Stop production or abandon investments if the outcomes are unfavorable at early
Put another way, real option advocates believe that you should be
paying a premium on discounted cashflow value estimates.
A bad investment…"
Becomes a good one…"
Three Basic Questions"
When is there a real option embedded in a decision or an asset?
When does that real option have significant economic value?
Can that value be estimated using an option pricing model?
When is there an option embedded in an action?"
An option provides the holder with the right to buy or sell a specified
quantity of an underlying asset at a fixed price (called a strike price or
an exercise price) at or before the expiration date of the option.
There has to be a clearly defined underlying asset whose value changes
over time in unpredictable ways.
The payoffs on this asset (real option) have to be contingent on an
specified event occurring within a...