How Can a Value Be Assigned to a Real Option

question 38

Essay

How can a value be assigned to a real option when we never know if it will be of any use when it has to be paid for? What kind of a number is the value assigned to a real option and how is it derived in capital budgeting? Is an assigned value always a true estimate or is it a limit, i.e. a minimum or a maximum? Why?

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Definitions:

Growth

An increase in the value of an asset or company, often measured by revenue, profits, or size expansion.

Normal Growth

In stock pricing models, growth at a rate less than the rate of return. Growth rates in excess of the rate of return are super normal.

Preferred Stock

A class of ownership in a corporation that has a higher claim on assets and earnings than common stock, typically with fixed dividends.

Annual Return

The percentage change in the value of an investment over a one-year period, including dividends, interest, and capital gains.