This document provides an overview of real options analysis, including: 1) An introduction to real options, explaining that real options give managers flexibility to respond to uncertainty, like the option to defer, expand, or abandon projects. 2) A section on identifying real options, noting options are often tied to phases, milestones, alternatives, and discretionary investments where decisions can be deferred. 3) A section on valuing real options, explaining flexibility has value accounted for using models like decision trees and Black-Scholes that value the ability to defer investments due to uncertainty. 4) A section on managing strategy as a portfolio of real options, where projects fall in a "tomato garden"

1. Options

2. Before we start… 3 Student Presentations Summing up based on the live-tweets 7 Introduction Introducing Real Options 11 Identify Identifying options 28 Value How to value Real Options 33 Manage Strategy as a portfolio of real options 53 Summary Summing real options up 60 The Exam How to do great at the exam! 62

3. Before We Start…

4. .. I need three volunteers? Before We Start…

5. Tweet key learnings… Before We Start… MCF10 Control10 Password:

6. Give a hand to thefellow students tweeting! Before We Start…

7. Student Presentations

8. The assignment for every study group! Every study-group should find 10 tweets that: You find interesting / funny That can serve as a either a summary of the lectures or that explores an important topic Reflect on these tweets As no one has uploaded a presentation we will turn this into a workshop – you have 20 minutes Two groups will present Student Presentations

9. Student Presentations Any volunteers?

10. Student Presentations If not then it will be….

11. Introduction

12. Introduction An option is the right, but not the obligation, to buy (or sell) an asset for a predetermined price within a predeterminedperiod of time Options arefinancial derivatives traded in financialmarkets

14. The value of the underlying asset

15. The volatility of the asset

16. The strike price

18. Life is Full of Options

19. Real Options Introduction A Real Option is the right, but not the obligation, to invest in a business opportunity or chose a particular course of action for developing, growing or abandoning an opportunity.

20. A Real Option in R&D Introduction In R&D, the (real) option is to develop a new technology or product, the investment is the project and the (underlying) asset is the future cash flows from product sales. Real options are not traded in a market.

21. Real Option and management flexibility Introduction watch & wait abandon engage & learn abandon staged development commit & commercialize abandon invest & proceed scale up/down abandon

22. Staging option and phase development Introduction earned value?proceed? earned value?proceed? product launch abandon abandon initial investment additional investment final investment

23. Introduction Strategy is a sequence of options So identify the options

24. Flexibility can be truly valuable

25. Driving without have a complete map For most companies strategy is like driving without a complete map. Strategy schools talk about planned vs. emergent strategy Introduction Planning Driving Time Having an incomplete map Adapt to signs, road and situation Therefore it is important to identify and value your options and allow for management flexibility as new information arises

26. What are the alternatives to Real Options? Bets – Guessing Net Present Value – several problems Decision Tree – disregards risk of underlying assets Introduction

28. It does not account for management flexibility – meaning that decisions can be deferred

29. It does not account for potential growth options

30. It does not value value delay and uncertainty to the same sophisticationIntroduction

31. Consider RO there is a high value of flexibility Introduction

33. How to work with Real Options Introduction

34. Identify

35. Identify options – look for the clues… Identify ”Phases”, ”StrategicInvestment”, ”Milestones”, ”Alternatives”, ”Scenarios”, etc... Examineprojectedcash flows: Identify the large investments – whichareoftendiscretionary – meaningtheyrequire a judgment and a decision.

36. Two conditions must be present Identify

37. Identify the important options Identify What are the important things managers will learn over time How will they use new information Which decisions will change following new information

38. 7S Framework – the different options Identify

39. Value

40. Value Flexibility has a value that should be accounted for in the valuation of a project

41. An investment opportunity as a Call option Value

42. Value

43. Value When do NPV and Option Pricingdiverge? WHEN THE INVESTMENT DECISIONS MAY BE DEFERRED

44. Value Conventional NPV misses the extravalueassociatedwithdeferralbecause it assumethat decisions can not be put off. In contrast option pricingpresumes the ability to defer and quantify the value of deferral

45. The two sources that drive value of deferral Value

46. Time Value of Money Value It is more attractive to investlaterthansooner.. ..thus the firstsource of value is the time value of the moneyuntil the decision no longer canbedeferred

47. Value of Volatility Value Uncertainty The value of the underlying asset can go up ordown – wedon’tknow

48. This relates to the metrics Value Value to Cost NPVq CummulativeVolatility

49. The Value to Cost ratio Value Value to Cost NPVq NPVq is a modification of the traditional NPV turned into a ratio

50. Value

52. Cumulative volatility Value CumulativeVolatility Variance of returns per unit of time multiplied with the number of periods - which expresses cumulative variance. Cumulative Volatility is the square root of the cumulative variance

53. Risk and Variance Value High Variance = High Risk Low Variance = Low Risk

54. Uncertainty and volatility is influenced by time Value Long time = Everything can happen Short time = Changes are predictable

55. Option Value Value

56. Value

57. Appendix – A service from me Value

58. Potentially use a calculator Value

59. Manage

60. Strategy as a Portfolio of Real Options

61. The Tomato Garden – Defined by Two Option ValueMetrics.. Manage

62. Low volatility Manage Volatility is very low, meaning uncertainty has been resolved or the time has run out

63. Project that are in the money Manage Projects are ”in the money” = NPV > 0 Reasonable predictions?

64. Out of the money – but promising value-to-cost Manage Out of the Money, but pomising value to cost Reseanoble Predictions

65. The impact of time (holding everything else equal) Manage Interets that can be earned until investing decreases Uncertainty has decreased

66. Summary

67. Summary Summary

68. The Exam

69. The exam No bullshitting – I’ve been there recently Be pro-active – take initiative Read the slides Understand the key elements and connect the dots Pre- Prepare and make an effort Then you will do great!! The exam