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International Financial Management                        Mahesh Kumar Sarva, Lovely Professional University




                    Notes             Unit 14: Real Options and Cross-border Investments


                                     CONTENTS
                                     Objectives
                                     Introduction

                                     14.1 Types of Real Options
                                          14.1.1  Options Relating to Project Size
                                          14.1.2  Options Relating to Project Life and Timing
                                          14.1.3  Options Relating to Project Operation

                                     14.2 Valuation
                                          14.2.1  Applicability of Standard Techniques
                                          14.2.2  Options-based Valuation
                                          14.2.3  Valuation Inputs
                                          14.2.4  Valuation Methods

                                     14.3 Foreign Direct Investments
                                          14.3.1  Why do Firms Invest Abroad?
                                     14.4 Methods to Increase Cross-border Investments
                                     14.5 Summary

                                     14.6 Keywords
                                     14.7 Review Questions
                                     14.8 Further Readings


                                   Objectives

                                   After studying this unit, you will be able to:
                                       Explain the types of real options

                                       Discuss the valuation methods
                                       Explain foreign direct investments
                                       Discuss the methods to increase cross border investments

                                   Introduction

                                   Real options, sometimes also referred to as strategic options, are a tool that can be employed in
                                   capital budgeting analysis to help companies make better critical strategic decisions. As with
                                   financial market traded options, real options can be valued using pricing models. Real options
                                   give the holder the right but, importantly, not the obligation, to take a particular course of
                                   action. Real options are a mechanism by which a business can attempt to place an actual value on
                                   the choice of taking a particular option, and can play a valuable role in helping a company assess
                                   the financial implications of various strategic options. Real options are commonly used when
                                   dealing with the decision to initiate a new project or to abandon an existing project, depending



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