Real Option - Decision Tree Analysis

Dr. Mohammed R. Ahmed

Input Area:
Investment Today
Cost of Capital
State of Nature:
Good
Bad
Delayed Investment
State of Nature:
Good
Bad

Year-0
-$1,500

Year-1

Year-2

Year-3

Year-4

Year-5

$500
$25

$500
$25

$500
$25

$500
$25

$500
$25

$500
0

$500
0

$500
0

$500
0

10.00%
P(X)
0.75
0.25
1.00

-$1,500
P(X)
0.75
0.25
1.00

$0

Process Area:
Investment Today
NPV (good)
Expected NPV (good)
NPV (bad)
Expected NPV (bad)
Expected NPV

$934.21
$700.66
-$1,378.29
-$344.57
$356.08

Investment Delayed
NPV (good)
Expected NPV (good)
NPV (bad)
Expected NPV (bad)
Expected NPV

$616.03
$462.02
-$1,500.00
$0.00
$462.02

Output Area:
Net Present Value:
Invest Today
Delay - Investment

$356.08
$462.02

Change in NPV

$105.94

-$1,500

Year-6

Year-7

$500
$25

$500
$25

$500
0

$500
0