Understanding NPV and Real Options Essay
Order ID 53563633773 Type Essay Writer Level Masters Style APA Sources/References 4 Perfect Number of Pages to Order 5-10 Pages
Understanding NPV and Real Options Essay
Understanding, NPV, Real Options, Essay
This discussion has 2 parts:
Understanding what the net present value (NPV) tells us.
The NPV decision rule says to accept the project if the NPV is greater than zero. You perform a thorough capital budgeting analysis on a project that requires a $1,000,000,000 initial investment and calculate the net present value (NPV) as $1. Following the rule, you tell your boss she should accept the project. She laughs and says “do you think I would really invest $1,000,000,000 for a measly $1 NPV? You should be fired” How would you respond to her?
Give two examples of “real options” that you have come across in your professional life, or that may come up in projects in a business you wish to start, or that may come up in the projects at a company in which you hope to be employed.
Your initial post should be at least 200 words, formatted and cited in current APA style with support from at least 2 academic sources. Your initial post is worth 8 points.
You should respond to at least two of your peers by extending, refuting/correcting, or adding additional nuance to their posts. Your reply posts are worth 2 points (1 point per response.)
Classmate post 1
Part 1. In my opinion, any capital budgeting decision is to maximize the net present value of the projects which will create wealth for the shareholders of the firm. Even $1 NPV by investing $ 1 billion is creating value and the project should not be abandoned IF no higher alternate projects are present.
Part 2. One real option that my wife lived while she worked for a local construction company is that they were operating with huge losses and unable to recover the company fixed costs. By doing a future forecasting they knew that they needed to make decisions like removing employees, future projects to have less cost.
The company had done those actions but it came to the point where they only had the option to abandon. Another example of real options can be seen with local restaurants. There is one local smoothie place that saw it had high demands from one part of the city. the owners figured that other parts of town might enjoy his product as well so they decided to look for shareholders and share their success. This business has been very successful in our town for about 5 years so they felt safe to go in to different parts of town and still have the same success. This can be seen as option to expand.
Classmate post 2
My response would address my boss’s lack of confidence in the goal. I would remind her of the priority behind any capital budgeting decision is to maximize the net present value of the projects and therefore create wealth for the shareholders of the company. The concept of using NPV is standard (Berkovitch, 2004).
Also, I would inform her that the $1 net present value does not mean that the profit is $1. This is the wealth generated for the shareholders after providing for the required return to the shareholders. Finally, I would tell my boss that a $1 net present value by investing a billion dollars is creating value, and thus if there is no other better opportunity, this project should be taken and considered as an opportunity to grow.
Real options may improve the net present value of a project (Moyer, McGuigan, & Rao, 2018). It allows managers to make decisions that change the value of capital budgeting decisions made in the present and future. In my personal experience owning a restaurant, when profits increased, we decided on the option to expand.
We considered opening a new restaurant to grow our business. In my present venture, a midwifery practice, a real option that we have taken is the timing option. We have delayed investment in a home birth project to understand better the demand for outputs and the cost of inputs. In addition, our goal for choosing this real option is to get more information on the benefits and risks associated with home births and how this project is going to pan in the future.
Berkovitch, E. &. (2004). Why the NPV Criterion Does Not Maximize NPV. The Review of Financial Studies, 17(1), 239-255.
Moyer, R. C., McGuigan, J. R., & Rao, R. (2018). Contemporary financial management. Mason, OH: Cengage-Southwestern.
QUALITY OF RESPONSE NO RESPONSE POOR / UNSATISFACTORY SATISFACTORY GOOD EXCELLENT Content (worth a maximum of 50% of the total points) Zero points: Student failed to submit the final paper. 20 points out of 50: The essay illustrates poor understanding of the relevant material by failing to address or incorrectly addressing the relevant content; failing to identify or inaccurately explaining/defining key concepts/ideas; ignoring or incorrectly explaining key points/claims and the reasoning behind them; and/or incorrectly or inappropriately using terminology; and elements of the response are lacking. 30 points out of 50: The essay illustrates a rudimentary understanding of the relevant material by mentioning but not full explaining the relevant content; identifying some of the key concepts/ideas though failing to fully or accurately explain many of them; using terminology, though sometimes inaccurately or inappropriately; and/or incorporating some key claims/points but failing to explain the reasoning behind them or doing so inaccurately. Elements of the required response may also be lacking. 40 points out of 50: The essay illustrates solid understanding of the relevant material by correctly addressing most of the relevant content; identifying and explaining most of the key concepts/ideas; using correct terminology; explaining the reasoning behind most of the key points/claims; and/or where necessary or useful, substantiating some points with accurate examples. The answer is complete. 50 points: The essay illustrates exemplary understanding of the relevant material by thoroughly and correctly addressing the relevant content; identifying and explaining all of the key concepts/ideas; using correct terminology explaining the reasoning behind key points/claims and substantiating, as necessary/useful, points with several accurate and illuminating examples. No aspects of the required answer are missing. Use of Sources (worth a maximum of 20% of the total points). Zero points: Student failed to include citations and/or references. Or the student failed to submit a final paper. 5 out 20 points: Sources are seldom cited to support statements and/or format of citations are not recognizable as APA 6th Edition format. There are major errors in the formation of the references and citations. And/or there is a major reliance on highly questionable. The Student fails to provide an adequate synthesis of research collected for the paper. 10 out 20 points: References to scholarly sources are occasionally given; many statements seem unsubstantiated. Frequent errors in APA 6th Edition format, leaving the reader confused about the source of the information. There are significant errors of the formation in the references and citations. And/or there is a significant use of highly questionable sources. 15 out 20 points: Credible Scholarly sources are used effectively support claims and are, for the most part, clear and fairly represented. APA 6th Edition is used with only a few minor errors. There are minor errors in reference and/or citations. And/or there is some use of questionable sources. 20 points: Credible scholarly sources are used to give compelling evidence to support claims and are clearly and fairly represented. APA 6th Edition format is used accurately and consistently. The student uses above the maximum required references in the development of the assignment. Grammar (worth maximum of 20% of total points) Zero points: Student failed to submit the final paper. 5 points out of 20: The paper does not communicate ideas/points clearly due to inappropriate use of terminology and vague language; thoughts and sentences are disjointed or incomprehensible; organization lacking; and/or numerous grammatical, spelling/punctuation errors 10 points out 20: The paper is often unclear and difficult to follow due to some inappropriate terminology and/or vague language; ideas may be fragmented, wandering and/or repetitive; poor organization; and/or some grammatical, spelling, punctuation errors 15 points out of 20: The paper is mostly clear as a result of appropriate use of terminology and minimal vagueness; no tangents and no repetition; fairly good organization; almost perfect grammar, spelling, punctuation, and word usage. 20 points: The paper is clear, concise, and a pleasure to read as a result of appropriate and precise use of terminology; total coherence of thoughts and presentation and logical organization; and the essay is error free. Structure of the Paper (worth 10% of total points) Zero points: Student failed to submit the final paper. 3 points out of 10: Student needs to develop better formatting skills. The paper omits significant structural elements required for and APA 6th edition paper. Formatting of the paper has major flaws. The paper does not conform to APA 6th edition requirements whatsoever. 5 points out of 10: Appearance of final paper demonstrates the student’s limited ability to format the paper. There are significant errors in formatting and/or the total omission of major components of an APA 6th edition paper. They can include the omission of the cover page, abstract, and page numbers. Additionally the page has major formatting issues with spacing or paragraph formation. Font size might not conform to size requirements. The student also significantly writes too large or too short of and paper 7 points out of 10: Research paper presents an above-average use of formatting skills. The paper has slight errors within the paper. This can include small errors or omissions with the cover page, abstract, page number, and headers. There could be also slight formatting issues with the document spacing or the font Additionally the paper might slightly exceed or undershoot the specific number of required written pages for the assignment. 10 points: Student provides a high-caliber, formatted paper. This includes an APA 6th edition cover page, abstract, page number, headers and is double spaced in 12’ Times Roman Font. Additionally, the paper conforms to the specific number of required written pages and neither goes over or under the specified length of the paper.
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