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Real Options - Essay Example

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The writer of this essay suggests that real options analysis is applied in decision making under uncertainty and in corporate finance management. Naturally, real options, under a flexible management, relate to project timing, size and how a project will operate upon establishment…
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Download file to see previous pages Use of standard techniques to evaluate real options
Traditionally the use of standard techniques was predominant though lacked merit in its application. The techniques included use discounted cash flows and net present value analysis. Here, future expected cash flows are treated as the present values of the empirical probability measure that reflects the risk of the project under a discounted rate. Cash flows that is expected are highly valued in this approach than any other flexible issue that alters the strategy to market goal realizations. The net present value approach presents management as being passive to their
Capital investment. Most analysts account for this real option problem by adjusting the discount rates. However, real options valuation looks at management as being active and they revolve interests with varying market trends. Real options usually bring into action the best contingency plan. Management has a duty to fight any negative occurrences by lowering the possibilities of exposure and limit the firm’s benefits from uncertainties in the market.
The contingent characteristic of profits to be realized in the future of a business, in real options models is exhibited by applying financial option techniques. Using the risk-neutral measure approach comprises the reduction of the probability distribution for the risk being accounted for. Real options valuation accounts for uncertainties in the future of definite parameters that define the value of the business. ...Download file to see next pagesRead More
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