Mastering Financial Mathematics in Microsoft Excel, 3rd Edition

13

Real options

Real options

Black–Scholes model

Binomial model

Exercise

Summary

 

File: MFMaths3e_13.xls

REAL OPTIONS

Traditional investment analysis using net present value principles dictates that projects should be accepted if they achieve a positive net value when discounted at a risk-adjusted cost of capital. Since a model of this kind is a simplification of potential real-world scenarios, it follows that no model can include all the complexities of the relevant factors or there are uncertainties about the nature and connectivity of the inputs. For example, cash flow models assume that management can take no action to change cash flows or that an investment is ‘all or nothing’ and cannot be increased, scaled back or abandoned. Although ...