A large telecommunication company faces an opportunity to invest in a SuperCom p

Question

A large telecommunication company faces an opportunity to invest in a SuperCom project that will revolutionize the way consumers use telephones, internet and TV. They have used the NPV methods to evaluate the project and the project is determined to have a positive NPV. However, the congress is currently debating the viability and process by which to allocate or auction the airwaves that are crucial to the commercial success of SuperCom. The company's lobbyist in Washington advices that the debate would be resolved within a year. It is also noted that time is of the essence for projects like this. What are the real options that can be created for this project and under what conditions can each real option be useful or executed?

Explanation / Answer

Ans.:)

Traditional capital budgeting approaches are based on discounted cash flow techniques, which require a number of assumptions about future market structure, demand, and operating costs. If these assumptions are not correct, the actual cash flow will be overestimated, and managers will need to adapt the old decision to the new situation, or even modify the entire strategy. This flexibility can be dealt with [modelled] by basing strategic investment decisions on “real options” techniques, using the notion of an option which represent the right, but not the obligation, to buy or sell a specific asset in the future. Real options are a powerful instrument to avoid or reduce sunk costs, a major problem for the telecommunications operators. In this three day course the basic real options evaluation techniques will be presented, including the relationships among cost models and investment evaluation in the telecommunications industry.

The objectives of the course are: to show the differences between classical capital budgeting and real option evaluation techniques; to explain why and how real options can provide a more flexible instrument for decision making and for project management; and to show how real options can be used in telecommunications asset evaluation, incorporating cost models and impact in the regulatory arena.

Traditional capital budgeting overview

Financial objectives of a company , Discounted cash flow techniques: NPV and IRR , Role of taxes and depreciation , Sensitivity analysis and decision tree analysis , Management of risk , Capital asset pricing model

Examples and applications.

Option-pricing basics and applications ( Limits and failures of traditional capital budgeting , Financial options and real options: a comparison , Classification of real options , Multiple real options , Net present value distribution in presence of real options , Project evaluation including real options , Applications to strategic decisions )

Application of real option investment analysis to the telecommunications industry

TELRIC models and their impact on investment appraisal Adapting cost models to real options

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