Real Option Expenses Harvard Case Solution & Analysis

Problem 2

Part a

The discounted cash flow approach is used in order to determine the Net Present Value of each of the round as well as in order to identify the appropriate discount rate to use. As, 15% discount rate is too high whereas 10% was too low so, the NPV for nine years is calculated by using the discount rate 11%, 12%,13% and 14%.From the calculation it is analyzed that the Net Present Value (NPV) is showing the negative future expected value for the new product that is near to belaunch. The committee should focus on the level of the discount rate that would result in the highly favorable and positiveNPVas it would help the company to achieve outcomes.

Additionally,it recommended to include only the Round 1 in their proposal of launch and exclude the preceding two rounds.However, the NPV of the Round1 to Round 3 by using discount rates from 11% to 14% is causing the negative cash flows. The company can used the discount rate of 11% as at this rate the situation of the Round 1-3 is better in comparison with the other discount rates. But on the other side it is also recommended that the company should use the discount rate lower than the 10% that must result in the highly positive NPV and it would give the favorable outcomes.

Part b

The Black-Scholes Model is used to evaluate the portfolio of options, where there as an opportunity to invest $450 during the six period of time. However, the standard deviation of returns range between 40%-60% and the risk free rate for calculating the present value from the Black-Scholes Model is 5%.The calculated present value is $ 450 million and from the analysis it is recommended that it is beneficial for the company to make investment for the launch of the new product as expected future value of the options are favorable.

Furthermore, it is recommendedthat the company should need to analyze all the external and internal factors that can impact the effective launch of the product while carefully overcoming the issues related to the use of discount rate. Likewise it is also recommended that creating awareness in the market is also an important factor and creating effective and efficient business strategies in order to successfully introduce the new product in the market.

Part c

The 6 year opportunity should be incorporated in a way that enhances the overall profitability of the company while minimizing thereduction in the cost. In addition to this, it must focus on the issues that arise from the valuation of the Present value from the Black-Scholes Model. Moreover, it must determine the volatility as well as determine the value of the underlying assets and it is also incorporated in option based analysis in the way that would not affect the values of underlying assets.

Problem 3

Part a.

Market A

P=0.5

1-P= 0.5

Expected value of the project Sable = 0.5($160) +0.5($80)

= $80+ $40

= $120

The NPV for the market A is $120 that indicates that this market is a good option to enter the market. In addition to this, the expected future value ($120) for market A is more as compared to the initial investment ($100) that is made in order to enter the market. However, entering the market A would provide the opportunity to target different group of customers as the expected future value would be $20 more than the initial investment that  help  to efficiently operate the business activities while  targeting potential customers to meet their expectation.

Market B

P=0.5

1-P= 0.5

Expected value of the project Sable = 0.5($140) +0.5($25)

= $70+ $12.5

= $82

The NPV for the market B is $82 that indicates that this market is also a better option to enter. In addition to this, the expected future value ($82) for market B is more as compared to the initial investment ($55) that is made in order to enter the market B. Therefore, the positive NPV of the market B shows that it is also favorable market for the company.........................

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