(BQ) Part 2 book “Fundamentals of financial management” has contents: Required returns and the cost of capital, operating and financial leverage, capital structure determination, dividend policy, the capital market, mergers and other forms of corporate restructuring, and other contents. | 9/19/08 17:04 Page 353 14 Risk and Managerial (Real) Options in Capital Budgeting Contents l l Objectives The Problem of Project Risk After studying Chapter 14, you should be able to: An Illustration • Expectation and Measurement of Dispersion: A Cash-Flow Example l Define the “riskiness” of a capital investment project. l Understand how cash-flow riskiness for a particular period is measured, including the concepts of expected value, standard deviation, and coefficient of variation. l Describe methods for assessing total project risk, including a probability approach and a simulation approach. l Judge projects with respect to their contribution to total firm risk (a firm-portfolio approach). l Understand how the presence of managerial (real) options enhances the worth of an investment project. l List, discuss, and value different types of managerial (real) options. Total Project Risk Probability Tree Approach • Simulation Approach • Use of Probability Distribution Information l Contribution to Total Firm Risk: Firm-Portfolio Approach Expectation and Measurement of Portfolio Risk • An Illustration • Correlation Between Projects • Combinations of Risky Investments l Managerial (Real) Options Valuation Implications • The Option to Expand (or Contract) • The Option to Abandon • The Option to Postpone • Some Final Observations l l l l l l Key Learning Points Questions Self-Correction Problems Problems Solutions to Self-Correction Problems Selected References “Risk? Risk is our business. That’s what this starship is all about. That’s why we’re aboard her!” —JAMES T. KIRK captain of the starship Enterprise 353 •• 9/19/08 17:04 Page 354 Part 5 Investment in Capital Assets In the preceding chapter, we assumed that the acceptance of any investment proposal would not alter the business-risk complexion of the firm as perceived by the suppliers of capital. This assumption allowed us to use a single required rate of .
