Summary
A recent discussion centers on the concept of options in corporate finance, particularly in relation to valuing projects and patents. The conversation begins with a hypothetical scenario involving a startup with a new technology that is currently not viable due to high implementation costs. The speaker emphasizes the importance of understanding options, particularly the option to delay, which allows companies to wait for potentially better market conditions before committing to a project.
The discussion further explores how the value of an option can increase with uncertainty. The speaker illustrates this by comparing traditional project valuation methods with real options analysis, highlighting that options can provide significant value even when initial assessments suggest a project is not feasible. The conversation also touches on the growing relevance of real options in corporate finance, noting that many firms, including consulting giants like McKinsey, are increasingly incorporating these concepts into their analyses.
In practical terms, the speaker outlines how to value patents as options, emphasizing the need to consider the underlying asset, the cost of conversion, and the time value associated with the option. By applying the Black-Scholes model, the speaker demonstrates how to derive the value of a patent, illustrating that the potential for future cash flows can significantly enhance the perceived value of a project. This approach allows companies to make more informed investment decisions, particularly in high-risk industries like pharmaceuticals, where the timing and viability of drug development can greatly impact financial outcomes.
Show Notes
In today's class, I did a quick introduction to real options, setting up the intuitive rationale for real options. We covered the basics of options, starting with why real options are so attractive to analysts and investors: they allow you to add a premium to your DCF value. The two building blocks for real option value are learning (from what is going on around you or ongoing events) and adapting your behavior. There are three questions that underlie the use of real options. The first is recognizing when you are dealing with an option, with a payoff diagram being the give away. The second is looking for exclusivity which is what gives options value. The third is using an option pricing model, which is built on replication and arbitrage. We then turned our attention to the option to delay, an option that can make the rights to bad project/technology valuable. We used it as a lever to talk about valuing patents and natural resource reserves as options, with significant caveats on both. Start of the class test: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/tests/realoption1.pdfSlides: http://www.stern.nyu.edu/~adamodar/podcasts/valUGspr17/session23.pdfPost class test: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session23Ctest.pdfPost class test solution: http://www.stern.nyu.edu/~adamodar/pdfiles/eqnotes/postclass/session23Csoln.pdf Learn more about your ad choices. Visit megaphone.fm/adchoices
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