Type of Real Options

Following are broad type of Real Options

(a) Growth Options: Sometimes it may be possible that some projects have a negative or insignificant even the managers may be interested in accepting the project as it may enable companies to find considerable profitability and add values in future. Some of the examples of such options are as follows:

• Investment in R&D activities

• Heavy expenditure on advertisement

• Initial investment in foreign market to expand business in future

• Acquiring making rights

• Acquisition of vacant plot with an intention to develop it in future.

The purposes of making such investments are as follows:

• Defining the competitive position of firm hence it is called strategic investments.

• Gaining knowledge about project’s from profitability.

• Providing the manufacturing and making flexibility to the firm.

Type of Real Options

(b) Abandonment Option:

As we have already studied in Capital Budgeting (at IPCC level) that once funds have been committed in any Capital Budgeting project it can not be recorded without incurring a heavy loss. However, in some cases due to change in economic conditions the firm may like to opt for adordoming the project without incurring further huge loses.

The option to abandon the project is similar to a put option where option to a abandon the project shall be exercised if value derived from project’s assets is more than PV of continuing project for one or more period.

(c) Timing Option: In traditional capital budgeting the project can either be accepted or rejected, implying that this will be undertaken or forever not. However, in real life situation a sometime a third choice also arises i.e. delay the decision until later, in i.e. option when to invest. Possible reasons for this delay may be availability of better information or ideas later on. This case of real option is similar to American call option and generally Binomial Model or Risk Material Method is option pricing are used in such situations.

Type of Real Options

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