Real Options Savola

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Finance 412
Dr.Eskandar Tooma
Fall 2010

Savola Sime Egypt
Case Study

Mayamine El Saady 900061728
May Farag 900060338
Marina Hanna 900060272
Amina Hussein900061146
Introduction:
Real option analysis (ROA) is a decision-making structure that basically calculates the value of a future business decision. ROA borrows from financial options theory. A financial option gives the buyer of a financial asset the right, but not the obligation, to buy a stock or bond, for example, at a predetermined price at a future date. By analogy, a real option is a managerial decision-making tool that calculates the value of a business decision that a manager has an option, or right, but not an obligation to fulfill. Basically, there are two types of real options Growth and Flexibility. Growth options help the company to increase its future business such as in the research and development, brand development, leasing or developing land, mergers and acquisitions and most important initiating a new technology. Flexibility options are different as they give the firm the ability to change its plan in the future and adapt to a new one. For example, the company may want to buy the option to delay, expand, contract, switch uses, outsource or abandon projects. Real options are considered powerful analytical tools as they capture the value of managerial flexibility to adapt decisions that would help to take an action towards any unexpected market developments. Companies associate their investment portfolio by identifying, managing and exercising real options to create shareholder value. In addition to that, real options recognize the staged nature of many investments and account explicitly for the reality that certain investments will never be made, if, based on additional information developed over time, they are deemed unattractive. In such cases, it makes sense to simply abandon them rather than entering into a poor investment. In fact, real options analysis is a useful tool for making investment decisions, taking into account uncertainty and building flexibility in the system. Despite the fact that more firms are using Net Present Value, it does not mean that it is the right decision to take the opportunity to invest. Traditional methods such as the Net Present Value, on the other hand, fail to take into consideration the economic value of investments where there is an environment full of uncertainty and changing rapidly. Moreover, making capital budgeting decisions also fails to take into consideration critical factors that may improve future cash flow as a result of the introduction of a new technology. That is why the real options method is now the new state of the art technique for the valuation and management of strategic investments. In addition to that, real option methods should enable corporate decision makers to take control over uncertainty and limit downside risk such as in the case of Savola that should consider a list of real options that are to help to improve capital investment planning and results.

Project background:
Savola Sime Egypt was one of the largest companies in the Egyptian edible oil and ghee market. Its CFO felt they have an opportunity to expand by capturing more market shares; it would expand by increasing its factory capacity, as it has already reached its maximum capacity. As a result of high forecasted growth in the Egyptian economy in 1997, the CFO was optimistic and he proposed the project of expansion to the parent company. The parent company requested a complete report on the financial feasibility of the project. Two teams were assigned to analyze the new project. The first team, financial experts, used the traditional capital budgeting methods in calculating the Net Present Value and the Initial return rate. They made some assumptions, upon which they base their analysis, * Cash Flow is done over 5 years

* Cost of debt in U.S dollars was about 9.8%
*...
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