Abstract
In this article, author has designed a real-life example to demonstrate evaluation of real options. He has selected a Power Generators Company which is reviewing an “Option to delay” for a special solar power generators project. Author has collected current data from market and has made realistic assumptions about future cash flows, volatility and time horizon. Based on this information, he has first calculated the value of project using discounted cash flow techniques and then calculated the value of the project by real option valuation techniques, using Black-Scholes model. He has used excel spreadsheets for above computations and has varied critical inputs to demonstrate their impact on net present value (NPV) and real option value which is supported by graphical illustrations also.In the final section, Author has discussed the difference between NPV and real option value, explaining why or why not one should always be greater than the other and which variables affect the difference between these two valuations. Finally, he has assessed the reliability of the conclusions obtained using NPV versus real options approach.
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