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Real options in capital budgeting, forecasting, types of leases, evaluate an IPO

1. What are real options? Why is it important for managers to determine the value of real options in capital budgeting decisions? Using an example explain how you can determine the value of a real option in the capital budgeting decision. In your response, include an example (use research article to answer the question).

2. Identify the tools and techniques available to mangers in the area of forecasting and planning. Discuss how you will use these tools to forecast sales and prepare a financial plan for you company.

3. Discuss the traditional argument that the firm can lower its cost of capital and increase market value of the firm using leverage and the non-traditional argument that leverage is irrelevant. Based on the understanding of the two sides, which approach will you use if you have to make a decision on capital structure in your firm.

4. Distinguish between operating leases and financial leases. Would you be more likely to find an operating lease employed for a fleet of aircraft or a manufacturing plant? Explain.

5. Select a company (domestic or international) who is planning to issue an IPO in next few months and evaluate their company's prospects (focus on future financial performance), management presentations, analyst reviews, and experts' opinion to determine the potential success of the issue. In your discussion include factors such as pricing, timing, and potential for profits for investors.

Solution Preview

1. Real option can be defined as an alternative or choice that becomes available with the opportunities of investment for any organization or individual. It is also known as call option on real asset. The main reason of being real option important to the managers in the capital budgeting decision is its support and the ability to expand the strategic frame work of the organization. Along with this real option also bridges organizational infrastructure, strategy and finance all together. Analysis obtained by using real option serves as a catalyst within an organization as it identifies the important points to the managers to take important decisions.
If we take an example of research article written by Tom Arnold and Timothy Falcon Crack "real option valuation using NPV, the net present value (NPV) using risk adjusted discount rates, we can find that this capital budgeting technique produces a real option valuation similar to the risk neutral option valuation. Here, the cash flow expected is multiplied with its probability and then the risk adjusted cash flow is obtained for each year. Now these cash flows are discounted back to find out the NPV of the project. If the NPV is positive the project is accepted by the managers but if the NPV is negative the project gets rejected by the managers.

2. There are various tools and techniques for ...

Solution Summary

The real options in capital budgeting is discussed. The tools and techniques available to managers in the area of forecasting and planning are identified.