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Could you please explain me what the following means:
Payback period has been suggested to be a proxy for the redeployment real option.Thank you in advance,
On its own it doesn’t really mean anything. Maybe it makes more sense in the context in which it was written.
I have read this sentence within the study text. In the explanation of payback period it is written: Payback period is used by many firms as a coarse filter of investments and it has been suggested to be a proxy for the redeployment real option.
I think I understand what they are trying to say, although I don’t really agree with all of it.
(And I certainly would not write it in the exam – the examiner doesn’t 🙂 )The longer the payback period is, the more uncertain the future flows are and therefore the more uncertain it is that the investment will be worthwhile.
Therefore in deciding whether or not to consider an option to redeploy, it is investments with a longer payback period that we would be most interested in looking at. In that sense it could be used as a coarse filter. I would not however regard it really as a proxy for the option – I think their choice of words is not good 🙂
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