Modeling Real Options
When faced with the possibility of undertaking a new project, a company must make the decision of whether to pursue that project. A standard way to do this is to perform an analysis based on the expected cash that will be realized by the project. Recall from Chapter 7, Section 7.2.4, that a stock has a required rate of return k that is higher than the risk-free rate owing to its risk, and the expected net present value of the stock (intrinsic value) is computed using k. Similarly, a risky investment in a project has associated with it a rate, called the risky discount rate, which is used to compute the net present ...
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