Exclusive Rights and the Option Feature

A firm in an extremely competitive sector is faced with a project that has a negative net present value currently and wants to know how much the option to delay the project is worth. Which of the following would you think is the right response?

a. It should be the value from the option pricing model b. It should be zero c. Neither Explain.

Implications Of Viewing The Right To Delay A Project As An Option

Several interesting implications emerge from the analysis of the option to delay a project as an option. First, a project may have a negative net present value based upon expected cash flows currently, but it may still be a "valuable" project because of the option characteristics. Thus, while a negative net present value should encourage a firm to reject a project, it should not lead it to conclude that the rights to this project are worthless. Second, a project may have a positive net present value but still not be accepted right away because the firm may gain by waiting and accepting the project in a future period, for the same reasons that investors do not always exercise an option just because it is in the money. This is more likely to happen if the firm has the rights to the project for a long time, and the variance in project inflows is high. To illustrate, assume that a firm has the patent rights to produce a new type of disk drive for computer systems and that building a new plant will yield a positive net present value right now. If the technology for manufacturing the disk drive is in flux, however, the firm may delay taking the project in the hopes that the improved technology will increase the expected cash flows and consequently the value of the project.

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