6. Valuing the growth option with the Black-Scholes option pricing model Aa Aa Real option analysis can be used to alter the timing, scale, or other aspects of an investment in response to market conditions. Businesses face the dilemma of whether to invest in a project or abandon it if it does not add value to the firm. Real option analysis allow financial managers to determine the financial consequences of this flexibility and the value of the option Consider the case of Fat Sheep Media Company: Fat Sheep Media Company, a social networking company, has seen triple-digit growth in its website's registrations over the past two years. Most of the website's subscribers live outside the United States, and the company is seeing a significant increase in the number of users from Brazil. As a result, Fat Sheep is considering opening a marketing office in Brazil to expand its marketing efforts there Management, however, is not sure if the Brazilian expansion via the opening of a subsidiary office will necessarily help the company grow and increase its value. Management's uncertainty is the result of the possibility that Brazil's Internet connectivity will be insufficient to support a of Fat Sheep's forecasted growth. One of Fat Sheep's employees, Luana, who is originally from Brazil, conducted some preliminary market research and submitted the following details about the potential five-year project: ning the new marketing office in Brazil will require an initial investment of $4.00 million Ope According to research on Brazil's mobile technology infrastructure, Luana noted there is a 60% probability that the country's mobile connectivity will be sufficient to generate additional advertising cash flows of $6.00 million per year for the company for the next five years Alternatively, there is a 40% chance that Brazil's mobile Internet connectivity will be insufficient to support Fat Sheep's desired growth in Brazil. In this case, the company expects to generate additional net advertising-related annual cash flows of only $2.00 million for the next five years The project's expected cost of capital is 14.00%, and the risk-free rate is 4%. The project's WACC should be used to 6. Valuing the growth option with the Black-Scholes option pricing model Aa Aa Real option analysis can be used to alter the timing, scale, or other aspects of an investment in response to market conditions. Businesses face the dilemma of whether to invest in a project or abandon it if it does not add value to the firm. Real option analysis allow financial managers to determine the financial consequences of this flexibility and the value of the option Consider the case of Fat Sheep Media Company: Fat Sheep Media Company, a social networking company, has seen triple-digit growth in its website's registrations over the past two years. Most of the website's subscribers live outside the United States, and the company is seeing a significant increase in the number of users from Brazil. As a result, Fat Sheep is considering opening a marketing office in Brazil to expand its marketing efforts there Management, however, is not sure if the Brazilian expansion via the opening of a subsidiary office will necessarily help the company grow and increase its value. Management's uncertainty is the result of the possibility that Brazil's Internet connectivity will be insufficient to support a of Fat Sheep's forecasted growth. One of Fat Sheep's employees, Luana, who is originally from Brazil, conducted some preliminary market research and submitted the following details about the potential five-year project: ning the new marketing office in Brazil will require an initial investment of $4.00 million Ope According to research on Brazil's mobile technology infrastructure, Luana noted there is a 60% probability that the country's mobile connectivity will be sufficient to generate additional advertising cash flows of $6.00 million per year for the company for the next five years Alternatively, there is a 40% chance that Brazil's mobile Internet connectivity will be insufficient to support Fat Sheep's desired growth in Brazil. In this case, the company expects to generate additional net advertising-related annual cash flows of only $2.00 million for the next five years The project's expected cost of capital is 14.00%, and the risk-free rate is 4%. The project's WACC should be used to
