Investment Decision-making Using Optional Models

David Heller is a Professor-Researcher in Finance and Head of the Master's course in Finance at ISC Paris, France.

• Introduction ixChapter 1. Risk and Flexibility Integration in Valuation 11.1. Introduction 11.2. The scope of real options 21.2.1. The concept of real options 31.2.2. Empirical use of real options 71.2.3. Paradigms in options 121.3. Valuation of investments by real options 201.3.1. Optional valuation of investments in a discrete-time approach 201.3.2. Optional valuation of investments in a continuous-time approach 281.4. Option model extensions by incorporating new parameters (Levyne and Sahut 2008) 351.4.1. Stochastic volatility 361.4.2. Transaction costs and models with jumps 391.4.3. Option pricing 411.5. Conclusion 44Chapter 2. Optional Modeling of Investment Choices and Surplus Value Linked to the Option to Invest 472.1. Introduction 472.2. Framework of optional interactions and option to develop an investment project 482.2.1. Real investment opportunity 502.2.2. Opportunity to postpone decision-making to infinity 522.2.3. Development cycle and taking into account new information within dependent projects and focusing on research and development 622.3. Option to exchange and abandon an investment project 652.3.1. Real options within the replacement cycle and disinvestment alternatives 662.3.2. The value of an investment project in the natural resources sector 692.3.3. Valuation of the abandonment option by investors 852.4. Growth option resulting from investment decisions and acquisition strategies 882.4.1. Company profiles justifying growth option value 892.4.2. Growth option value related to interactions between financing and investment decisions 902.4.3. Acquisition strategies by the real options approach 982.5. Conclusion 106Chapter 3. Data Generation Applied to Strategic and Operational Option Models 1073.1. Introduction 1073.2. Determining the right time to invest 1073.2.1. Application to the carry option 1083.2.2. Application of the Dixit and Pindyck model 1103.3. Flexibility of asset exchange, abandonment and temporary shutdown of projects 1133.3.1. Application to the exchange option 1133.3.2. Application to the abandonment option 1153.3.3. Application to the temporary shutdown option 1163.4. Incorporation of development phases 1213.4.1. Implementation of a two-stage investment project 1213.4.2. Valuation of a sequential project 122Conclusion 135Appendices 139Appendix 1. Demonstration of the CRR Formula 141Appendix 2. Stochastic Differential Calculus 147Appendix 3. Test of the Black and Scholes Formula and Return on the Log–Normal Distribution 155Appendix 4. Demonstration of the Black and Scholes Formula 159Bibliography 165Index 173