REAL OPTION APPROACH

REAL OPTION APPROACH

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Question 1.

Throughout this case, the study of the NPV is inadequate since it cannot place a dollar value management stability on the side of volatility. For Country Line Markets, the choice to enlarge the shop to a megastore is dependent on several factors and is just an alternative. The threat of Walmart opening stores is significant, and, with changing trends dynamics, the decision to build a shop immediately or to wait for the right moment can never be taken into account in the NPV evaluation and risk evaluation.

Question 2.

The advantages to being gained by exploring the real options perspective are;

1. a) the choice of delaying the launch, effectively a time choice,
2. b) the extension of the shop for more customer satisfaction.

Question 3.

Volatility for the present value of the free cash flows in the future using the Arzac approach.

Question 4.

The strengths and weaknesses of Arzac approach

Strengths: If the data is collected, this is a straightforward solution to variability.

Weaknesses: The planner will have to have a representation of the likelihood-based on a variety of expectations (He, 2019). As the lowest and highest potential revenue will rely on a variety of different variables, and that may lead to errors. Separate confidence rates would give differing volatility outcomes. If anyone were to be using the Black-Scholes method for realistic options, this could provide an extensive range in valuation outcomes.

Question 5.

Binomial lattice model for the CLM superstore

The model of simulation would at the end generate the following

Binomial lattice

Question 6.

Comparison between the result of NPV and option value

The Arzac approach is easy to use, but it yields only one indicator of variance and, over a more extended time, may lead to significant statistical errors. On the opposite, the simulation method uses FCFs in two intervals and measures the relative variance on a regular relative scale. As it is distributed over 17 years, it gives managers a clearer understanding of the value of the underlying value and the way it produces the cash flows. This is also much more reliable than forecasting the variability of the first-year sales only in the Arzac target-based forecast.

Question 7.

Sensitivity analysis

It indicates that there are alternate ways of thinking about specific actual options. They could split down the large project into a series of unrelated investments, which could then be fed into the implicit value of the options (Cong, 2019). Another way to practice pricing options is to run a pilot scheme and then review the outcomes of the pilot scheme and, if successful, run it as a real project. This brings similar results to the pricing of products.

Question 8.

The solution to real options is to apply the principle of job options to alternatives for real / non-financial properties. Options are discretionary decisions that offer an incentive to choose after confusion has arisen. Uncertainty and the willingness of the agent to react to it (flexibility) are the sources of the quality of choice. Correct options valuations are correlated with financial sector valuations wherever necessary.

References

Cong, L. W. (2019). Auctions of real options. Available at SSRN 2136359.

He, J., Alavifard, F., Ivanov, D., & Jahani, H. (2019). A real-option approach to mitigate disruption risk in the supply chain. Omega, 88, 133-149. He, J., Alavifard, F., Ivanov, D., & Jahani, H. (2019). A real-option approach to mitigate disruption risk in the supply chain. Omega, 88, 133-149.