Real Options Analysis: Tools and Techniques for Valuing Strategic Investment and Decisions, 2nd Edition

Content: Chapter 1 A New Paradigm? 1 --
Chapter 2 Traditional Valuation Approaches 3 --
Chapter 3 Real Options Analysis 3 --
Chapter 4 The Real Options Process 5 --
Chapter 5 Real Options, Financial Options, Monte Carlo Simulation, and Optimization 5 --
Chapter 6 Behind the Scenes 6 --
Chapter 7 Real Options Models 7 --
Chapter 8 Additional Issues in Real Options 8 --
Chapter 9 Introduction to the Real Options Valuation's Super Lattice Solver Software and Risk Simulator Software 8 --
Chapter 10 Real Options Valuation Application Cases 9 --
Chapter 11 Real Options Case Studies 9 --
Chapter 12 Results Interpretation and Presentation 10 --
Part 1 Theory --
Chapter 1 A New Paradigm? 15 --
A Paradigm Shift 15 --
Expansion and Compound Options: The Case of the Operating System 17 --
Expansion Options: The Case of the E-Business Initiative 20 --
Expansion and Sequential Options: The Case of the Pharmaceutical R & D 22 --
Expansion and Switching Options: The Case of the Oil and Gas Exploration and Production 23 --
Abandonment Options: The Case of the Manufacturer 26 --
Expansion and Barrier Options: The Case of the Lost Venture Capitalist 27 --
Compound Expansion Options: The Case of the Internet Start-Up 29 --
The Real Options Solution 30 --
Issues to Consider 31 --
Industry Leaders Embracing Real Options 32 --
What the Experts Are Saying 36 --
Criticisms, Caveats, and Misunderstandings in Real Options 38 --
Appendix 1A The Timken Company on Real Options in R & D and Manufacturing 41 --
Appendix 1B Schlumberger on Real Options in Oil and Gas 44 --
Appendix 1C Intellectual Property Economics on Real Options in Patent and Intangible Valuation 50 --
Appendix 1D Gemplus on Real Options in High-Tech R & d 53 --
Appendix 1E Sprint on Real Options in Telecommunications 57 --
Chapter 2 Traditional Valuation Approaches 63 --
The Traditional Views 63 --
Practical Issues Using Traditional Valuation Methodologies 65 --
Appendix 2A Financial Statement Analysis 76 --
Free Cash Flow Calculations 76 --
Free Cash Flow to a Firm 77 --
Levered Free Cash Flow 77 --
Inflation Adjustment 77 --
Terminal Value 78 --
Price-to-Earnings Multiples Approach 78 --
Discounting Conventions 80 --
Appendix 2B Discount Rate versus Risk-Free Rate 84 --
The CAPM versus the Multifactor Asset-Pricing Model 85 --
Chapter 3 Real Options Analysis 87 --
The Fundamental Essence of Real Options 87 --
The Basics of Real Options 89 --
A Simplified Example of Real Options in Action 89 --
Advanced Approaches to Real Options 91 --
Why Are Real Options Important? 92 --
Comparing Traditional Approaches with Real Options 95 --
Chapter 4 The Real Options Process 103 --
Critical Steps in Performing Real Options Analysis 103 --
Chapter 5 Real Options, Financial Options, Monte Carlo Simulation, and Optimization 109 --
Real Options versus Financial Options 109 --
Monte Carlo Simulation 112 --
Part 2 Application --
Chapter 6 Behind the Scenes 123 --
Real Options: Behind the Scenes 123 --
Binomial Lattices 127 --
The Look and Feel of Uncertainty 131 --
A Firm's Real Options Provide Value in the Face of Uncertainty 134 --
Binomial Lattices as a Discrete Simulation of Uncertainty 136 --
Risk Versus Uncertainty, Volatility versus Discount Rates 139 --
Granularity Leads to Precision 146 --
An Intuitive Look at the Binomial Equations 151 --
Frolicking in a Risk-Neutral World 156 --
Chapter 7 Real Options Models 163 --
Option to Abandon 163 --
Option to Expand 167 --
Option to Contract 170 --
Option to Choose 174 --
Simultaneous Compound Options 177 --
Changing Strikes 180 --
Changing Volatility 182 --
Sequential Compound Option 184 --
Extension to the Binomial Models 187 --
Appendix 7A Volatility Estimates 190 --
Logarithmic Cash Flow Returns Stock Price Returns Approach 191 --
Logarithmic Present Value Returns Approach 197 --
GARCH Approach 203 --
Management Assumption Approach 204 --
Market Proxy Approach 211 --
Volatility versus Probability of Technical Success 211 --
Appendix 7B Black-Scholes in Action 213 --
Appendix 7C Binomial Path-Dependent and Market-Replicating Portfolios 215 --
Appendix 7D Single-State Static Binomial Example 221 --
Differential Equations 221 --
Optimal Trigger Values 225 --
Appendix 7E Sensitivity Analysis with Delta, Gamma, Rho, Theta, Vega, and Xi 227 --
Call Delta 228 --
Call Gamma 229 --
Call Rho 229 --
Call Theta 229 --
Call Vega 230 --
Call Xi 231 --
Appendix 7F Reality Checks 232 --
Theoretical Ranges for Options 232 --
SMIRR and SNPV Consistency 232 --
Minimax Approach 233 --
Implied Volatility Test 233 --
Appendix 7G Applying Monte Carlo Simulation to Solve Real Options 235 --
Applying Monte Carlo Simulation to Obtain a Real Options Result 235 --
Applying Monte Carlo Simulation to Obtain a Range of Real Options Values 239 --
Appendix 7H Trinomial Lattices 242 --
Appendix 7I Nonrecombining Lattices 244 --
Chapter 8 Additional Issues in Real Options 255 --
Project Ranking, Valuation, and Selection 255 --
Decision Trees 256 --
Exit and Abandonment Options 259 --
Compound Options 260 --
Timing Options 260 --
Solving Timing Options Calculated Using Stochastic Optimization 262 --
Switching Options 267 --
Appendix 8A Stochastic Processes 272 --
Summary Mathematical Characteristics of Geometric Brownian Motions 272 --
Summary Mathematical Characteristics of Mean-Reversion Processes 273 --
Summary Mathematical Characteristics of Barrier Long-Run Processes 273 --
Summary Mathematical Characteristics of Jump-Diffusion Processes 274 --
Appendix 8B Differential Equations for a Deterministic Case 275 --
Appendix 8C Exotic Options Formulae 278 --
Black and Scholes Option Model-European Version 278 --
Black and Scholes with Drift (Dividend)-European Version 279 --
Black and Scholes with Future Payments-European Version 279 --
Chooser Options (Basic Chooser) 280 --
Complex Chooser 281 --
Compound Options on Options 282 --
Exchange Asset for Asset Option 283 --
Fixed Strike Look-Back Option 284 --
Floating Strike Look-Back Options 285 --
Forward Start Options 287 --
Generalized Black-Scholes Model 287 --
Options on Futures 288 --
Spread Option 289 --
Discrete Time Switch Options 290 --
Two-Correlated-Assets Option 290 --
Part 3 Software Applications --
Chapter 9 Introduction to the Real Options Valuation's Super Lattice Software and Risk Simulator Software 295 --
Introduction to the Super Lattice Solver Software 296 --
Single Super Lattice Solver 297 --
Multiple Super Lattice Solver 305 --
Multinomial Lattice Solver 307 --
SLS Excel Solution (SSLS, MSLS, and Changing Volatility Models in Excel) 309 --
SLS Functions 311 --
Lattice Maker 314 --
Introduction to the Risk Simulator Software 315 --
Monte Carlo Simulation 316 --
Forecasting 331 --
Optimization 343 --
Appendix 9A Financial Options 348 --
Black-Scholes Model 349 --
Appendix 9B Probability Distributions for Monte Carlo Simulation 351 --
Understanding Probability Distributions 351 --
Selecting a Probability Distribution 353 --
Monte Carlo Simulation 353 --
Probability Density Functions, Cumulative Distribution Functions, and Probability Mass Functions 354 --
Discrete Distributions 355 --
Continuous Distributions 362 --
Appendix 9C Forecasting 375 --
Time-Series Forecasting 375 --
Multiple Linear Regression 376 --
Appendix 9D Optimization 377 --
What Is an Optimization Model? 377 --
Decision Variables 380 --
Constraints 380 --
Requirements 382 --
Types of Optimization Models 383 --
Chapter 10 Real Options Valuation Application Cases 385 --
American, European, Bermudan, and Customized Abandonment Option 386 --
American, European, Bermudan, and Customized Contraction Option 396 --
American, European, Bermudan, and Customized Expansion Option 403 --
Contraction, Expansion, and Abandonment Option 409 --
Basic American, European, and Bermudan Call Options 414 --
Basic American, European, and Bermudan Put Options 415 --
Exotic Chooser Options 419 --
Sequential Compound Options 421 --
Multiple-Phased Sequential Compound Option 424 --
Customized Sequential Compound Options 426 --
Path-Dependent, Path-Independent, Mutually Exclusive, Nonmutually Exclusive, and Complex Combinatorial Nested Options 428 --
Simultaneous Compound Option 430 --
American and European Options Using Trinomial Lattices 432 --
American and European Mean-Reversion Option Using Trinomial Lattices 434 --
Jump-Diffusion Option Using Quadranomial Lattices 436 --
Dual-Variable Rainbow Option Using Pentanomial Lattices 438 --
American and European Lower Barrier Options 440 --
American and European Upper Barrier Option 443 --
American and European Double Barrier Options and Exotic Barriers 446 --
American ESO with Vesting Period 449 --
Changing Volatilities and Risk-free Rates Options 449 --
American ESO with Suboptimal Exercise Behavior 452 --
American ESO with Vesting and Suboptimal Exercise Behavior 453 --
American ESO with Vesting, Suboptimal Exercise Behavior, Blackout Periods, and Forfeiture Rate 455 --
Chapter 11 Real Options Case Studies 459 --
Case 1 High-Tech Manufacturing-Build or Buy Decision with Real Options 459 --
Case 2 Financial Options-Convertible Warrants with a Vesting Period and Put Protection 467 --
Case 3 Pharmaceutical Development-Value of Perfect Information and Optimal Trigger Values 473 --
Case 4 Oil and Gas-Farm Outs, Options to Defer, and Value of Information 476 --
Case 5 Valuing Employee Stock Options Under 2004 FAS 123 478 --
Case 6 Integrated Risk Analysis Model-How to Combine Simulation, Forecasting, Optimization, and Real Options Analysis into a Seamless Risk Model 527.