Real Options Analysis: Tools and Techniques for Valuing Strategic Investment and Decisions, 2nd Edition (Wiley Finance)

"Mun demystifies real options analysis and delivers a powerful, pragmatic guide for decision-makers and practitioners alike. Finally, there is a book that equips professionals to easily recognize, value, and seize real options in the world around them." —Jim Schreckengast, Senior VP, R&D Strategy, Gemplus International SA, France Completely revised and updated to meet the challenges of today's dynamic business environment, Real Options Analysis, Second Edition offers you a fresh look at evaluating capital investment strategies by taking the strategic decision-making process into consideration. This comprehensive guide provides both a qualitative and quantitative description of real options; the methods used in solving real options; why and when they are used; and the applicability of these methods in decision making. Content: Chapter 1 A New Paradigm? 1 -- Chapter 2 Traditional Valuation Approaches 3 -- Chapter 3 Real Options Analysis 3 -- Chapter 4 The Real Options Process 5 -- Chapter 5 Real Options, Financial Options, Monte Carlo Simulation, and Optimization 5 -- Chapter 6 Behind the Scenes 6 -- Chapter 7 Real Options Models 7 -- Chapter 8 Additional Issues in Real Options 8 -- Chapter 9 Introduction to the Real Options Valuation's Super Lattice Solver Software and Risk Simulator Software 8 -- Chapter 10 Real Options Valuation Application Cases 9 -- Chapter 11 Real Options Case Studies 9 -- Chapter 12 Results Interpretation and Presentation 10 -- Part 1 Theory -- Chapter 1 A New Paradigm? 15 -- A Paradigm Shift 15 -- Expansion and Compound Options: The Case of the Operating System 17 -- Expansion Options: The Case of the E-Business Initiative 20 -- Expansion and Sequential Options: The Case of the Pharmaceutical R & D 22 -- Expansion and Switching Options: The Case of the Oil and Gas Exploration and Production 23 -- Abandonment Options: The Case of the Manufacturer 26 -- Expansion and Barrier Options: The Case of the Lost Venture Capitalist 27 -- Compound Expansion Options: The Case of the Internet Start-Up 29 -- The Real Options Solution 30 -- Issues to Consider 31 -- Industry Leaders Embracing Real Options 32 -- What the Experts Are Saying 36 -- Criticisms, Caveats, and Misunderstandings in Real Options 38 -- Appendix 1A The Timken Company on Real Options in R & D and Manufacturing 41 -- Appendix 1B Schlumberger on Real Options in Oil and Gas 44 -- Appendix 1C Intellectual Property Economics on Real Options in Patent and Intangible Valuation 50 -- Appendix 1D Gemplus on Real Options in High-Tech R & d 53 -- Appendix 1E Sprint on Real Options in Telecommunications 57 -- Chapter 2 Traditional Valuation Approaches 63 -- The Traditional Views 63 -- Practical Issues Using Traditional Valuation Methodologies 65 -- Appendix 2A Financial Statement Analysis 76 -- Free Cash Flow Calculations 76 -- Free Cash Flow to a Firm 77 -- Levered Free Cash Flow 77 -- Inflation Adjustment 77 -- Terminal Value 78 -- Price-to-Earnings Multiples Approach 78 -- Discounting Conventions 80 -- Appendix 2B Discount Rate versus Risk-Free Rate 84 -- The CAPM versus the Multifactor Asset-Pricing Model 85 -- Chapter 3 Real Options Analysis 87 -- The Fundamental Essence of Real Options 87 -- The Basics of Real Options 89 -- A Simplified Example of Real Options in Action 89 -- Advanced Approaches to Real Options 91 -- Why Are Real Options Important? 92 -- Comparing Traditional Approaches with Real Options 95 -- Chapter 4 The Real Options Process 103 -- Critical Steps in Performing Real Options Analysis 103 -- Chapter 5 Real Options, Financial Options, Monte Carlo Simulation, and Optimization 109 -- Real Options versus Financial Options 109 -- Monte Carlo Simulation 112 -- Part 2 Application -- Chapter 6 Behind the Scenes 123 -- Real Options: Behind the Scenes 123 -- Binomial Lattices 127 -- The Look and Feel of Uncertainty 131 -- A Firm's Real Options Provide Value in the Face of Uncertainty 134 -- Binomial Lattices as a Discrete Simulation of Uncertainty 136 -- Risk Versus Uncertainty, Volatility versus Discount Rates 139 -- Granularity Leads to Precision 146 -- An Intuitive Look at the Binomial Equations 151 -- Frolicking in a Risk-Neutral World 156 -- Chapter 7 Real Options Models 163 -- Option to Abandon 163 -- Option to Expand 167 -- Option to Contract 170 -- Option to Choose 174 -- Simultaneous Compound Options 177 -- Changing Strikes 180 -- Changing Volatility 182 -- Sequential Compound Option 184 -- Extension to the Binomial Models 187 -- Appendix 7A Volatility Estimates 190 -- Logarithmic Cash Flow Returns Stock Price Returns Approach 191 -- Logarithmic Present Value Returns Approach 197 -- GARCH Approach 203 -- Management Assumption Approach 204 -- Market Proxy Approach 211 -- Volatility versus Probability of Technical Success 211 -- Appendix 7B Black-Scholes in Action 213 -- Appendix 7C Binomial Path-Dependent and Market-Replicating Portfolios 215 -- Appendix 7D Single-State Static Binomial Example 221 -- Differential Equations 221 -- Optimal Trigger Values 225 -- Appendix 7E Sensitivity Analysis with Delta, Gamma, Rho, Theta, Vega, and Xi 227 -- Call Delta 228 -- Call Gamma 229 -- Call Rho 229 -- Call Theta 229 -- Call Vega 230 -- Call Xi 231 -- Appendix 7F Reality Checks 232 -- Theoretical Ranges for Options 232 -- SMIRR and SNPV Consistency 232 -- Minimax Approach 233 -- Implied Volatility Test 233 -- Appendix 7G Applying Monte Carlo Simulation to Solve Real Options 235 -- Applying Monte Carlo Simulation to Obtain a Real Options Result 235 -- Applying Monte Carlo Simulation to Obtain a Range of Real Options Values 239 -- Appendix 7H Trinomial Lattices 242 -- Appendix 7I Nonrecombining Lattices 244 -- Chapter 8 Additional Issues in Real Options 255 -- Project Ranking, Valuation, and Selection 255 -- Decision Trees 256 -- Exit and Abandonment Options 259 -- Compound Options 260 -- Timing Options 260 -- Solving Timing Options Calculated Using Stochastic Optimization 262 -- Switching Options 267 -- Appendix 8A Stochastic Processes 272 -- Summary Mathematical Characteristics of Geometric Brownian Motions 272 -- Summary Mathematical Characteristics of Mean-Reversion Processes 273 -- Summary Mathematical Characteristics of Barrier Long-Run Processes 273 -- Summary Mathematical Characteristics of Jump-Diffusion Processes 274 -- Appendix 8B Differential Equations for a Deterministic Case 275 -- Appendix 8C Exotic Options Formulae 278 -- Black and Scholes Option Model-European Version 278 -- Black and Scholes with Drift (Dividend)-European Version 279 -- Black and Scholes with Future Payments-European Version 279 -- Chooser Options (Basic Chooser) 280 -- Complex Chooser 281 -- Compound Options on Options 282 -- Exchange Asset for Asset Option 283 -- Fixed Strike Look-Back Option 284 -- Floating Strike Look-Back Options 285 -- Forward Start Options 287 -- Generalized Black-Scholes Model 287 -- Options on Futures 288 -- Spread Option 289 -- Discrete Time Switch Options 290 -- Two-Correlated-Assets Option 290 -- Part 3 Software Applications -- Chapter 9 Introduction to the Real Options Valuation's Super Lattice Software and Risk Simulator Software 295 -- Introduction to the Super Lattice Solver Software 296 -- Single Super Lattice Solver 297 -- Multiple Super Lattice Solver 305 -- Multinomial Lattice Solver 307 -- SLS Excel Solution (SSLS, MSLS, and Changing Volatility Models in Excel) 309 -- SLS Functions 311 -- Lattice Maker 314 -- Introduction to the Risk Simulator Software 315 -- Monte Carlo Simulation 316 -- Forecasting 331 -- Optimization 343 -- Appendix 9A Financial Options 348 -- Black-Scholes Model 349 -- Appendix 9B Probability Distributions for Monte Carlo Simulation 351 -- Understanding Probability Distributions 351 -- Selecting a Probability Distribution 353 -- Monte Carlo Simulation 353 -- Probability Density Functions, Cumulative Distribution Functions, and Probability Mass Functions 354 -- Discrete Distributions 355 -- Continuous Distributions 362 -- Appendix 9C Forecasting 375 -- Time-Series Forecasting 375 -- Multiple Linear Regression 376 -- Appendix 9D Optimization 377 -- What Is an Optimization Model? 377 -- Decision Variables 380 -- Constraints 380 -- Requirements 382 -- Types of Optimization Models 383 -- Chapter 10 Real Options Valuation Application Cases 385 -- American, European, Bermudan, and Customized Abandonment Option 386 -- American, European, Bermudan, and Customized Contraction Option 396 -- American, European, Bermudan, and Customized Expansion Option 403 -- Contraction, Expansion, and Abandonment Option 409 -- Basic American, European, and Bermudan Call Options 414 -- Basic American, European, and Bermudan Put Options 415 -- Exotic Chooser Options 419 -- Sequential Compound Options 421 -- Multiple-Phased Sequential Compound Option 424 -- Customized Sequential Compound Options 426 -- Path-Dependent, Path-Independent, Mutually Exclusive, Nonmutually Exclusive, and Complex Combinatorial Nested Options 428 -- Simultaneous Compound Option 430 -- American and European Options Using Trinomial Lattices 432 -- American and European Mean-Reversion Option Using Trinomial Lattices 434 -- Jump-Diffusion Option Using Quadranomial Lattices 436 -- Dual-Variable Rainbow Option Using Pentanomial Lattices 438 -- American and European Lower Barrier Options 440 -- American and European Upper Barrier Option 443 -- American and European Double Barrier Options and Exotic Barriers 446 -- American ESO with Vesting Period 449 -- Changing Volatilities and Risk-free Rates Options 449 -- American ESO with Suboptimal Exercise Behavior 452 -- American ESO with Vesting and Suboptimal Exercise Behavior 453 -- American ESO with Vesting, Suboptimal Exercise Behavior, Blackout Periods, and Forfeiture Rate 455 -- Chapter 11 Real Options Case Studies 459 -- Case 1 High-Tech Manufacturing-Build or Buy Decision with Real Options 459 -- Case 2 Financial Options-Convertible Warrants with a Vesting Period and Put Protection 467 -- Case 3 Pharmaceutical Development-Value of Perfect Information and Optimal Trigger Values 473 -- Case 4 Oil and Gas-Farm Outs, Options to Defer, and Value of Information 476 -- Case 5 Valuing Employee Stock Options Under 2004 FAS 123 478 -- Case 6 Integrated Risk Analysis Model-How to Combine Simulation, Forecasting, Optimization, and Real Options Analysis into a Seamless Risk Model 527. "Mun demystifies real options analysis and delivers a powerful, pragmatic guide for decision-makers and practitioners alike. Finally, there is a book that equips professionals to easily recognize, value, and seize real options in the world around them."--Jim Schreckengast, Senior VP, R & D Strategy, Gemplus International SA, FranceCompletely revised and updated to meet the challenges of today's dynamic business environment, Real Options Analysis, Second Edition offers you a fresh look at evaluating capital investment strategies by taking the strategic decision-making process into consideration "Completely revised and updated to meet the challenges of today's dynamic business environment, Real Options Analysis, Second Edition offers a fresh look at evaluating capital investment strategies by taking the strategic decision-making process into consideration. This comprehensive guide provides both a qualitative and quantitative description of real options; the methods used in solving real options; why and when they are used; and the applicability of these methods in decision making."--Jacket