Valuation of real options Flashcards
1
Q
What are the four steps in DCF valuation?
A
- Estimation of discount rate → risk premium + financing structure of project
- Estimation of CFs = unlevered
- Estimation of TV
- Computation of NPV
2
Q
What are the limitations of a DCF analysis?
A
- Static
- Does not capture embedded options in investment
- Ignores flexibility in timing of investment
- Ignores value of option arising maybe in future
- Relies on difficult estimation of appropriate discount rate
3
Q
What are the different kind of options a firm might encounter in the future?
A
- Growth options
- Contraction options
- Flexibility options
- Option to default
- …
4
Q
Why do we use the term risk-neutral probabilities to describe these weights?
A
- Probabilities sum to 1
- Positive and mathematical convenience (discount CFs at rf)
- Do not need to resort on WACC
