How to perform an investment project valuation using real options with Fairmat

In this tutorial, we show how Fairmat Academic can be used to model and solve capital budgeting problems including real options. In particular we will do this by presenting an investment decision in the pharmaceutical industry.

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Closed Caption:

honey welcome to them that she too is
the release
in this video we should have them into
academic be used to model unsolved
capital budgeting problems
including contains decisions in
particular we would do this by
presenting investment decisions
pharmaceutical industry
the idea underlying the approach he
composes very simple
the capital budgeting problem be
decomposed into a set
simple decisions or options but probably
describing the hierarchy among
individual decisions
just a few types independent is needed
to so many capital budgeting problems
these basic Relations Committee combined
with one another to describe more
complex real life situations
to model this case the issue with the
following data are available
parameters and suggested processes see
documentation for details
the he is the president
you the cash flows excluding the real
options assuming the project is
implemented immediately
RSS the risk-free rate
Sigma is the volatility the ground
be
92 93 in the capital expenditures and
counting the cost to clinical trials
that use two and three respectively
s is the resale value vs ed
I E is the following host production
capacity
he is the extension lead to production
capacity
we modeled the cash loans to just
dynamic has a geometric Brownian motion
in them that this process is indicated
with the bomb
we n sling based on the and volatility
the constants defined previously
in capital budgeting need is common to
see the cost cap to returns constant
this means that the risk premium in the
discount rate to constant
however under risk neutral valuation
only the best female it is relevant
therefore we said Rs in the road field
create the problem structure
the option that in this option look
second stage is a pain and he is the
reason for the second stage clinical
trials
la third stage is a payment to you three
for the third stage clinical trials book
launch products 1
represent is to just pay off getting
from the new products yes signs
as you can see it as a function v1
local GB expand
productive capacity is the pay of the
option to increase the production
capacity years 6
is important in said at the time
payment in the window maturity
$2.9 million project
run in houses in that way she results
then displayed in the bottom panel
the valuation to you can also evaluate
the value the past and projected
by selecting the starting node in the
main menu well by left clicking on the
subsidy
no seen the company has the opportunity
to lead based on the abrasion
also abandoned her business in this
scheme the option to abandon the
exercise only before the first an
extension is exercised
this problem includes a selection of the
best option
and the compound option case in them and
create different scenarios related to
specific base case
by changing the type of options for
example who committed to european
in our case we are interested in showing
the difference in value between the
committee decision
unreal option OpenManage scenarios in
creating use an aria
insert name description and pre-existing
base case from which you want to delete
at the end select the news no
in the main menu loan to value option to
abandon the project
contingent on the way value the project
itself a little
feature as opposed to design right now
the best course of action
the OR operator allows us to do this
so after including upgrading the option
a
we had the T branches one which we go on
the plan described above the other in
which we burn
the over all traded every point in time
take the best if the two branches
in the amendment option may include the
resell value
projects in case it is abandoned the
year three
that he six we have
GMT texas-size an expansion option hence
changing the auction block
from the customer committed option to
stand in European option
he select the base case scenario you can
see the block all she be
expand productive capacity changes in
custom options and herbal
to the European option in green you must
disable the a-bands blog because these
options not exist in the base case
to compare the values in the two
scenarios
run the snow what-if analysis you will
obtain two cases
expanded and healing would be double
click on solution
the two figures represent the expected
value
and the probability distribution of the
two cases inverse figure we see the real
options values greater than the base
case than
in the second pic we notice real options
distribution is positive
and base case can have negative values
across the simulated pearls
now we show held
form a sensitivity analysis they're
interested in evaluating how the project
plan depends on market volatility
changes
to do that edit Sigma check the
sensitivities I'm
and she's arranged to do it in
sensitivity analysis is the study of
have been changes in the armpit
mathematical model can be apportioned
call it did legal constitutively
to different sources the variation in
need
winds with mom
now show how to perform an impact
analysis
which is the impact on the project value
for a specified variation of the
internet's
parameters we can calculate it through
all the parameters
to do that let impacts like in the
variables
the figure close the gap in the contract
value
caused by increase or decrease in the
end than
the black vertical bar is the expected
value of the contract
benchmark Hang in the variables
a ruling by a decrease in value than
that remember that then
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