Sequencing options: Projects can be implemented sequentially or in parallel.Switch options enable to switch between different modes of operation.Barrier options are taken if they reach a certain barrier.In one of my posts you can have a look at a simple option to choose. Options to choose allow to choose among several different options types.This option is also known as a termination option. If the present value of the remaining cash flows is smaller than the liquidation value, the asset may be sold. Option to abandon: Management may have the option to stop a project and to realise a salvage value.If this does not occur, the firm can shelve the patent not to generate additional costs. The firm will market and develop the product only if the present value of the expected cash flows from the product sales are higher than the development costs. Delay option with a product patent: A firm with a patent right on a product has a right to develop and market the product exclusively until the expiration of the patent.This constitutes an American styled call option. For example, in natural resource exploration a firm can delay mining a deposit until market conditions are favorable. Option to wait / defer: Management has the flexibility to postpone the start of an investment until more information is available.This option is also known as a Switching Option. A flexible manufacturing system (FMS) is a good example of this type of option. In one of my posts I provide a simple example. Management may shut down a part or all of the operation when conditions are unfavorable (put option), and may restart operations when conditions improve (a call option). Option to expand or contract: Depending on the return development, management takes the desired option to increase the benefit.This is equivalent to a put option in financial markets. Option to contract : If the returns of the project are lower than expected, management takes the opportunity to decrease capacity and save operational costs.This is equivalent to a call option in financial markets. Option to expand: If the returns of the project are higher than expected, management takes the opportunity to increase capacity.ROA shows what to do in which situation and provides specific recommendations to management. Real options analysis (ROA) evaluates strategic options and expands classic DCF models. A real option itself, is the right-but not the obligation-to undertake certain business initiatives, such as deferring, abandoning, expanding, staging, or contracting a capital investment project. Reality quite often differs from planning and management has to take corrective actions. Classical DCF Analysis evaluates specific planning scenarios and cannot consider strategic options.
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