Assignment Sheet
Emerging Markets Finance
Darden Graduate School of Business
Spring First Half 2002
Class #14, Wednesday, February 27, 2002
Topic: Capital projects as real options
Reading: Capital projects as real options: An introduction, HBS 295-074.
Reading (optional): Brealey and Myers, Principles of Corporate Finance, Chapter 21, Real Options. (If you don't have a copy of the text and would like to read it before the class, please contact me know. I have a copy, which you are welcome to borrow.)
The objective of this class is to consider the optionality in capital projects and how one maps project characteristics onto call option variables. I will also present my thought on the puzzle discussed in Class #12. To prepare for this class, I suggest that you review your note on financial options.
Assignment Questions:
- To get started analyzing corporate projects as real options, you need
to know the basic option pricing model and concepts.
- Start with terminology: call, put, exercise price, maturity, American/European options, in the money, out of the money, put-call parity.
- Understand how various factors affect the price of an option: volatility, exercise price, stock price, dividends, maturity.
- Know the assumptions for Black-Scholes option pricing model.
- What are the limitations of discounted cash flow analysis? Why does firm value often exceed assets in place?
- What type of investments are like call options? When should you invest? When should you wait? When should you expand? How do "dividends" fit in? What factors increase the value of call options?
- Is limited liability a put option? What factors increase the value of put options?
- How would map project characteristics onto option variables? If such a mapping exists, you can use Black-Scholes to value real options.