Capital Projects and Real Options
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Real options represent a company’s rights to make chronological decisions in a capital project.
Real options increase the NPV of a project because a firm would not rationally exercise an option which lowers value.
Types of Real Options
Evaluating Real Options
Calculate the project’s NPV without any options. If the project has a positive NPV, then real options will increase its value.
If the project without any options has a negative NPV, then make adjustments based on the value of associated real options. The analyst must determine if the value of the real options is sufficient to create a positive NPV.
Incorporate the use of decision trees or option pricing models to evaluate a capital project.