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Real options / WACC / Manufacturing plants abroad

Companies often have to increase their initial investment costs to obtain real options. Why might this be so, and how could a firm decide it was worth the cost to obtain a given real option?

How might a firm's corporate WACC be affected by the size of its capital budget?
Why do US corporations build manufacturing plants abroad when they can build them at home?

Solution Preview

1. Real options imply that the firm gets the ability to change the outcome of the capital budgets even after the project has been started. The firm would get the option to either abandon the project later on or to change the scope of the project. When the firm starts the project, it would enter into agreements with various suppliers for the inputs to the project. In order to get the real options, the risks of the suppliers increase since the project may be abandoned later on or changed and the suppliers would have done their own investments based on the project. Thus the firm may need to compensate the ...

Solution Summary

The solution explains real options, the impact on WACC of capital budget and why companies build manufacturing plants abroad