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The Economics of Business ValuationTowards a Value Functional Approach$
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Patrick Anderson

Print publication date: 2013

Print ISBN-13: 9780804758307

Published to Stanford Scholarship Online: September 2013

DOI: 10.11126/stanford/9780804758307.001.0001

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Real Options and Expanded Net Present Value

Real Options and Expanded Net Present Value

Chapter:
(p.166) 12 Real Options and Expanded Net Present Value
Source:
The Economics of Business Valuation
Author(s):

Patrick L. Anderson

Publisher:
Stanford University Press
DOI:10.11126/stanford/9780804758307.003.0012

This chapter demonstrates the importance of management flexibility regarding the timing, scale, and type of investments, which is the basis for the study of “real options.” The chapter describes an opportunity and its contractual equivalent, an option, the history of option contracts, the classic Black-Scholes-Merton option model of the firm, and the formula for pricing, under ideal conditions, a pure financial call option. From this basis, the author draws the conclusion that the existence of an option premium alone renders invalid the Net Present Value rule for the value of the firm. The author then describes techniques for valuing “real options,” including extensions of financial options methods, Decision Tree Analysis, Monte Carlo, stochastic control, and value functional models, and “good deal” bounds. Finally it describes a recently-proposed synthesis of traditional income methods and real options analysis, which the author calls “expanded net present value” or XNPV.

Keywords:   real option, Fisher, Black-Scholes-Merton model, Net Present Value rule, Decision Tree Analysis, stochastic control, value functional, recursive, expanded net present value, managerial flexibility

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