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1
OPTIONS
2
Before we start… 3
Introduction Introducing Real Options 11
Student Presentations Summing up based on the live-tweets 7
Identify Identifying options 28
Manage Strategy as a portfolio of real options 53
Value How to value Real Options 33
Summary Summing real options up 60
The Exam How to do great at the exam! 62
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3BEFORE WE START…
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.. I need three volunteers?
BEFORE WE START…
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Tweet key learnings…
BEFORE WE START…
Control10Password:
MCF10
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Give a hand to the fellow students tweeting!
BEFORE WE START…
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7STUDENT PRESENTATIONS
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The assignment for every study group! Every study-group should find 10 tweets that:
You find interesting / funny That can serve as a either a summary of the
lectures or that explores an important topic Reflect on these tweets
As no one has uploaded a presentation we will turn this into a workshop – you have 20 minutes
Two groups will present
STUDENT PRESENTATIONS
9STUDENT PRESENTATIONS
Any volunteers?
10STUDENT PRESENTATIONS
If not then it will be….
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11INTRODUCTION
12INTRODUCTION
An option is the right, but not the obligation, to buy (or sell) an asset for a predetermined price within a predetermined period of time
Options are financial derivatives traded in financial markets
13INTRODUCTION
The value of an option depends on:
• The time before exercising the option• The value of the underlying asset• The volatility of the asset• The strike price• The interest rate
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Definitions...
INTRODUCTION
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Life is Full of Options
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Real Options
INTRODUCTION
A Real Option is the right, but not the obligation, to invest in a business opportunity or chose a particular course of action for developing, growing or abandoning an opportunity.
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A Real Option in R&D
INTRODUCTION
In R&D, the (real) option is to develop a new technology or product, the investment is the project and the (underlying) asset is the future cash flows from product sales.
Real options are not traded in a market.
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Real Option and management flexibility
INTRODUCTION
watch & wait
engage & learn
commit & commercializestaged development
invest & proceedscale up/down
abandon
abandon
abandon
abandon
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Staging option and phase development
INTRODUCTION
earned value?proceed?
initial investment
additional investment
final investment
earned value?proceed? product
launchabandon abandon
20INTRODUCTION
Strategy is a sequence of
options
So identify the options
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Flexibility can be truly valuable
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Driving without have a complete mapFor most companies strategy is like driving without a complete map. Strategy schools talk about planned vs. emergent strategy
INTRODUCTION
Planning Driving
Having an incomplete map Adapt to signs, road andsituation
Time
Therefore it is important to identify and value your options and allow for management flexibility as new information arises
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What are the alternatives to Real Options? Bets – Guessing
Net Present Value – several problems
Decision Tree – disregards risk of underlying assets
INTRODUCTION
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Problems of traditional NPV
• It assumes that not investing results in flat line business performance
• It does not account for management flexibility – meaning that decisions can be deferred
• It does not account for potential growth options
• It does not value value delay and uncertainty to the same sophistication
INTRODUCTION
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Consider RO there is a high value of flexibility
INTRODUCTION
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How to work with Real Options
INTRODUCTION
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28IDENTIFY
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Identify options – look for the clues…
IDENTIFY
”Phases”, ”Strategic Investment”, ”Milestones”, ”Alternatives”, ”Scenarios”, etc...
Examine projected cash flows: Identify the large investments – which are often discretionary – meaning they require a judgment and a decision.
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Two conditions must be present
IDENTIFY
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Identify the important options
IDENTIFY
What are the important things managers will learn over time
How will they use new information
Which decisions will change following new information
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7S Framework – the different options
IDENTIFY
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33VALUE
34VALUE
Flexibility has a value that should be accounted for in the valuation of a project
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An investment opportunity as a Call option
VALUE
36VALUE
37VALUE
When do NPV and Option Pricing diverge?
WHEN THE INVESTMENT DECISIONS MAY BE DEFERRED
38VALUE
Conventional NPV misses the extra value associated with deferral because it assume that decisions can not be put off.
In contrast option pricing presumes the ability to defer and quantify the value of deferral
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The two sources that drive value of deferral
VALUE
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Time Value of Money
VALUE
It is more attractive to invest later than sooner..
..thus the first source of value is the time value of the money until the decision no longer can be deferred
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Value of Volatility
VALUE
Uncertainty
The value of the underlying asset can go up or down –
we don’t know
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This relates to the metrics
VALUE
Value to Cost
Cummulative Volatility
NPVq
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The Value to Cost ratio
VALUE
Value to Cost NPVq
NPVq is a modification of the traditional NPV turned into a ratio
44VALUE
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Cumulative volatility
VALUE
Cumulative Volatility
Variance of returns per unit of time multiplied with the number of periods - which expresses cumulative variance. Cumulative Volatility is the square root of the cumulative variance
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Risk and Variance
VALUE
High Variance = High Risk
Low Variance = Low Risk
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Uncertainty and volatility is influenced by time
VALUE
Long time = Everything can happen
Short time = Changes are predictable
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Option Value
VALUE
50VALUE
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Appendix – A service from me
VALUE
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Potentially use a calculator
VALUE
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53MANAGE
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Strategy as a Portfolio of Real Options
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The Tomato Garden – Defined by Two Option Value Metrics..
MANAGE
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Low volatility
MANAGE
Volatility is very low, meaning uncertainty has been resolved or the time
has run out
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Project that are in the money
MANAGE
Projects are ”in the money” =
NPV > 0
Reasonable predictions?
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Out of the money – but promising value-to-cost
MANAGE
Out of the Money, but pomising value
to cost
Reseanoble Predictions
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The impact of time (holding everything else equal)
MANAGE
Interets that can be earned until investing decreases
Uncertainty has
decreased
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60SUMMARY
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Summary
SUMMARY
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62THE EXAM
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The exam
No bullshitting – I’ve been there recently Be pro-active – take initiative Read the slides Understand the key elements and connect the
dots Pre- Prepare and make an effort
Then you will do great!!
THE EXAM
