Chapter $14.$ Real Options

Assume that you have just been hired as a financial analyst by Tropical Sweets Inc., a mid$-$alized Callitornia company that specializes in creating exotic candies from tropical fruits such as mangoes, papayas, and dates. The firm's CEO, George Yamaguchi, recently returned trom an industry corporate executlve conference in San Francisco, and one of the sessions he attended was on real options. Since ne one at Tropical Sweets is familiar with the basies of real options, Yamaguchi has asked you to prepare a brief report that the firm's executives could use to gain at least a cursory understanding of the topics.

a$.$ What are some types of real options?

b$.$ What are the five steps for analyzing a real option?

c$.$ Tropical Sweets is considering a project that will cost $$70$ million and will generate expected cash flows of $$30$ per year for three years. The cost of capital for this type of project is $10$ percent and the risk$-$free rate is $6$ percent. After discussions with the marketing department, you learn that there is a $30$ percent chance of high demand, with future cash flows of $$45$ million per year. There is a $40$ percent chance of average demand, with cash flows of $$30$ million per year. If demand is low $($a $30$ percent chance$),$ cash flows will be only $$15$ per year. What is the expected NPV$?$

REAL OPTIONS: THE INVESTMENT TIMING OPTION

$\backslash$table$[[$Coste$,-$$$70$