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Hello, i am so confused about Real options,
Do we have to compare the value of option with NPV without option?or do we have to add the value of option to NPV?
Secondly how do we know when to use Put option and when to use Call option?
The option makes the investment more attractive than if the option did not exist.
If there is no option (to delay or whatever) then we calculate the NPV and that is the end of it. However, if we have the option to (for example) ‘wait and see’ before we decide whether or not to invest (the option to delay) then again it makes it more attractive.
So, we add the value of the option to the NPV of the project to get an overall value of the whole thing.
Options to delay or to expand are call options.
Options to abandon or redeploy are put options.
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