SAINT PETERSBURG STATE UNIVERSITY

GRADUATE SCHOOL OF MANAGEMENT

 

COURSE SYLLABUS

 

Real Options and Strategic Management

 

Autumn semester 2009/2010 academic year

 

Instructor: Alexander Bukhvalov,

PricewaterhouseCoopers Professor of Finance, Department of Finance and Accounting

Email: bukhvalov@gsom.pu.ru

Web site: http://bukhvalov.som.pu.ru

 

Organization of the course

 

Program

Bachelor program (financial management)

Year

4

Course status

Elective

Workload

45 hours

Prerequisites

Financial Management

Teaching methods

Lectures, class discussions, homework, student presentations, case discussions

 

Course objectives

This course is devoted to strategic treatment of uncertainty. The concept of the real options analysis (ROA) provides both theoretical framework and workable instrument of decision making. The course presentation is interactive. Numerous mini-cases are discussed.

The area of ROA is the hi-end of modern strategic management and applications of corporate finance to the real world issues. The real options concept is to design flexibility rules to gain from positive trends and to protect from negative ones. The course includes applications to corporate finance, marketing, branding, international management, outsourcing, innovation, IT, and many other areas.

.

Key skills developed by students

 The course aims to develop different knowledge, skills and abilities:

Knowledge:

  1. Understanding impact of uncertainty on various facets of strategic management.
  2. Modern theories of strategic management under uncertainty
  3. Valuation and decision making instruments
  4. Classification of real options, binary trees techniques
  5. Basis model of real options: option to wait and learn
  6. Option to abandon, sequential investment option, option to expand/contract
  7. The capacity management: economies of scale vs flexibility
  8. International entry, acquisitions
  9. Brand valuation

 

Skills and abilities:

  1. Analysis of the main types of uncertainty and design of the relevant strategy in dynamics
  2. Being keen in finding real options
  3. Analytic decision making on (uncertainty) binary trees
  4. Understanding implementation of real options (contractual procedures, training)

 

 

Course content

Topic 1. Introduction to Real Options Analysis (ROA) 

Topic 2. The basic example and valuation

Topic 3. Valuation and decision making

Topic 4. Real options and strategy design

Topic 5. Group presentation

 

Plan of classes

 

Topic 1. Introduction to Real Options Analysis (ROA) 

Class 1.

September 4, 2009

6 hours

Key points for class 1:

  • Course objectives and tasks
  • Course rules and teaching methods
  • Introduction to strategic view of uncertainty
  • Real options concept
  • From SWOT analysis to ROA.

Learning outcomes:

  •  Understanding of the key points of management under uncertainty.

Assignments for Class 2:

Reading [BM]/[BMA], Chapter 20

 

Topic 2. The basic example and valuation

Class 2.

September 11, 2009

6 hours

Key points for class 2:

  • The basic RO example and its refinements
  • RO and industry structure
  • Classification of RO.
  • Basic model for decision making and valuation.
  • Mini-cases

Learning outcomes:

  • Understanding RO concepts and directions of its applications

Assignments for Class 3:

Reading [BM]/[BMA], Chapter 21.

 

Topic 3. Valuation and decision making

Class 3.

September 18, 2009

6 hours

Key points for Class 3:

·        Binary trees techniques

·        Replication issues.

  • Transaction costs
  • The Black-Scholes formula

Learning outcomes:

  • Understanding of the main steps in real options design
  • Valuation and decision making on binary trees
  • Replication and arbitrage possibilities
  • The use/misuse of the Black-Scholes formula for RO

Assignments for Class 4:

Reading [BM]/[BMA], Chapter 22.1–22.2

Class 4.

September 25, 2009

6 hours

Key points for Class 4:

  • Follow-up investment opportunities
  • The timing option
  • Mini-cases

Learning outcomes:

·        Capability to analyze and design timing and follow-up RO

·        Outsourcing as RO.

Assignments for Class 5:

Reading [BM]/[BMA], Chapter 22.3–22.4

Topic 4. Real options and strategy design

Class 5.

October 2, 2009

6 hours

Key points for Class 5:

  • Option to abandon
  • Option to expand/contract size/scope
  • Capacity management
  • Mini-cases 

Learning outcomes:

  • Understanding options to abandon and flexibility options.
  • RO in IT industries, modularity
  • RO and IM

Assignments for Class 6:

Reading [GT], Chapter 12

Class 6.

October 9, 2009

6 hours

Key points for Class 6:

  • Real options and corporate policy
  • Applications to real estate finance
  • Mini-cases

Learning outcomes:

  • Real estate valuation techniques
  • Risk management and RO

Assignments for Class 7:

Prepare the drafts of group presentation

 

Topic 5. Group presentation

Class 7.

October 16, 2009

6 hours

Key points for Class 7:

  • Implementation of real options
  • Survey of academic literature on real options
  • Sample presentation

Learning outcomes:

  • Understanding implementation mechanism by the use of contracts.

Assignments for Class8:

Prepare the final presentation

Class 8.

October 23, 2009

3 hours

Key points for Class 8:

  • Group presentations
  • Course summary

 

 

Office hours for individual consultations

Consultations are available on Fridays 16.30-18.00

 

Calendar plan of current and final evaluation

Submission of group project topic

September 18

Group presentations

October, 23

(perhaps October 16 as well depending on course enrollment)

Pre-exam consultation

October 23

Exam

October 30

Final results announcement

October 30

 

Grading system

  1. Home assignments – 30%
  2. Final group project – 10%
  3. Final written exam – 60%

 

Teaching Assistant

Kristina Lochakova, E-mail: lochakova@gsom.pu.ru

Home Assignments

Send by e-mail both to Bukhvalov and Lochakova by 9 p.m. on Thursday. Ms Lochakova is completely responsible for grading.

Final exam (3 academic hours) consists of 2 parts:

 

1. Two quantitative problems (50%)

2. Five essay questions (50%)

The final exam is based on the whole course issues and materials: theory, materials from articles, presentations, and discussions during the course.

This is open book examination: [BM], [BMA] and [GT] are allowed.

No electronic communication tools (notebooks, cell phones, etc) are allowed at the examination.

Take please ordinary (scientific/financial) calculator.

 

Required reading

Textbook

[BM] Brealey R.A. and  S.C. Myers. Principles of Corporate Finance. 7th ed.. McGraw-Hill, 2003. Chapters 20–22.

[BMA] Brealey R.A., S.C. Myers, and F. Allen. Corporate Finance. 8th ed.. McGraw-Hill, 2006. Chapters 20–22.

The required material in [BM] and [BMA] is practically identical. There is Russian translation of [BM] with poor Russian terminology.

Supplementary Textbook

[GT] Grinblatt M. and S. Titman. Financial Markets and Corporate Strategy. 2nd ed.. McGraw-Hill, 2002. Chapter 12.

Other readings (available through GSOM electronic resources):

Academic journal articles (should be used for group presentation; the choice must be approved by the lecturer):

Beinhocker E.D. 1999. Robust Adaptive Strategies. Sloan Management Review, Spring, 95–106.

Bernardo A.E., Chowdhry B. 2002. Resources, real options, and corporate strategy. Journal of Financial Economics 63 (2): 211–234.

Bowman E.H., Hurry D. 1993. Strategy through the options lens: an integrated view of resource investments and the incremental-choice process. Academy of Management Review 18 (4): 760–782.

Bowman E.H., Moskowitz G.T. 2001. Real options analysis and strategic decision making. Organization Science 12 (6): 730–743.

Brennan M.J., Schwartz E.S. 1985. Evaluating natural resource investments. Journal of Business 58 (2): 135–157.  

Capel J. 1997. A Real Options Approach to Economic Exposure Management // Journal of International Financial Management and Accounting, 8:2, 87–113.

Childs P.D., Triantis A.J. 1999. Dynamic R&D Investment Policies // Management Science, 45 : 10, 1359-1377.

Christensen C.M., Bower J.L. 1996. Customer power, strategic investment, and the failure of leading firms. Strategic Management Journal 17 (3): 197–218.

Christensen C.M. 1997. Making strategy: Learning by doing. Harvard Business Review 75 (6): 5–12.

Constantinides G.M. 1986. Capital market equilibrium with transaction costs. Journal of Political Economy 94 (4): 842–862.

Cortazar G., Schwartz E.S., Salinas M. 1998. Evaluating Environmental Investments: A Real Options Approach // Management Science, 44 : 8, 1059-1070.

Cortazar G., Schwartz E., Casassus J. 2001. Optimal Exploration Investments under Price and Geological Uncertainty: a Real Options Model. R&D Management Journal 31 (2): 181-189.

Courtney H.G., Kirkland J., Viguerie S.P. 1997. Strategy under uncertainty. Harvard Business Review 75 (3): 67–79.

Cox J.C., Ross S.A., Rubinstein M. 1979. Option pricing: a simplified approach. Journal of Financial Economics 7 (3): 229–263.

Dixit A. K., Pindyck R. S. 1995. The options approach to capital investment. Harvard Business Review, May-June, 106–115.

Fernandez P. 2001. Valuing real options: frequently made errors, SSRN.

Ghemawat P., del Sol P. 1998. Commitment versus Flexibility. California Management Review, 40 : 4, 26–42.

Kim W. Chan, Mauborgne R. 1997. Value innovation: The strategic logic of high growth. Harvard Business Review 75 (1): 103–112.

Kogut B. 1991. Joint ventures and the real option to expand and acquire. Management Science 37 (1): 19–33.

Kogut B., Kukatilaka N. 1994. Operating flexibility, global manufacturing, and option value of a multinational network. Management Science 40 (1): 123–139.

Kogut B., Kukatilaka N. 2001. Capabilities as real options. Organization Science 12 (6): 744–758.

Kulatilaka N., Marcus A.J. 1994. Valuing Employee Stock Options // Financial Analysts Journal (November-December): 46–56.

Kulatilaka N., Perotti E.C. 1998. Strategic Growth Options. Management Science 44 : 8, 1021-1031.

Kumar R.L. 1996. A note on project risk and option values of investments in information technologies. Journal of Management Information Systems 13 (1): 187–193.

Latimore D. 2000. Real Options: Another Way To Value Internet Initiatives. Financial Executive 23 (May/June): 26–27.

Longstaff F.A., Schwartz E.S. 2001. Valuing American Options by Simulation: A Simple Least-Square Approach. Review of Financial Studies 14 (1): 113–147.

Luehrman T.A. 1998. Investment Opportunities as Real Options: Getting Started on the Numbers. Harvard Business Review, July-August, 51–67.

Luehrman T.A. 1998. Strategy as a Portfolio of Real Options. Harvard Business Review, September-October, 89–99.

Luehrman T. A. 1997. What It Worth? A General Manager’s Guide to Valuation. Harvard Business Review, May-June, 67–79.

Margrabe W. 1978. The value of an option to exchange one asset for another. Journal of Finance 33 (1): 177–186.

McDonald R., Siegel D. 1986. The value of waiting to invest. The Quarterly Journal of Economics 101 (4): 705–727.

Moel A., Tufano P. 2002. When Are Real Options Exercised? An Empirical Study of Mine Closings. Review of Financial Studies. 15 (1): 35–64.

Myers St. 1997. Determinants of Corporate Borrowing. Journal of Financial Economics 5: 147–175.

Quigg L. 1993. Empirical Testing of Real Option-Pricing Models. Journal of Finance 48 (3): 621–639.

Schwartz E.S., Moon M. 2001. Rational Pricing of Internet Companies Revisited. Financial Review 36: 7–26.

Shi L., Aktan M. A real options design for product outsourcing. The Engineering Economist 48 (3), 199–217.

Stalk G., Jr., Evans P., Shulman L.E. 1992. Competing on capabilities: the new rules of corporate strategy. Harvard Business Review 70 (2): 57–69.

Takalo T., Kanniainen V. Do patents slow down technological progress? Real options in research, patenting, and market introduction // International Journal of Industrial Organization, 18 (2000), pp. 1105-1127.

Taudes A. 1998. Software growth options. Journal of Management Information Systems 15 (1): 165–186.

Titman S. 1985. Urban land prices under uncertainty. American Economic Review 75 (3): 505­–514.

Vonnegut A. Real option theories and investment in emerging economies // Emerging Markets Review, 1 (2000), pp. 82-100.

 

Appendix 1

 

Group presentation description

 
Group presentation is based on one or a number of academic articles from the Academic journal articles list above. 
It aims to provide additional information on ROA ideas and show the scope and diversity of existing applications. 
Presentation should contain the main idea of the article (series of articles) and a simple implementation of this idea to decision making 
(adapted from the article or original).
The list of articles consists both of technically advanced studies and mostly verbal descriptions of strategic issues in various areas of management. 
Choose please the topic of your interest subject to your skills and abilities.  
 

Requirements:

 

1. Groups formation and a company choice September 18

2. Deadline for written form: October 14

3. Group project should be sent by email to:  bukhvalov@gsom.pu.ru

4. Project presentation date: October 23 (October 16 is possible as well)

5. Group size: 4 persons
6. Submission form: Detailed Power Point presentation 
7. Group process: All group members must sign the submitted assignment to indicate agreement with the contents and to a common grade for each member of the group. All group members should participate in project presentation class. In case of absence, the student will not get 10% for project work in the final grade.
 

Appendix 2

 

Research Seminar on Corporate Finance and Real Options

 

Students interested in the topic are kindly invited to participate in the work of Seminar on Corporate Finance and Real Options, which takes place on Tuesdays at 19.00 at Volkhovky Lane, 3.

There is a possibility to present your own talks based on reviews of papers and/or to report on your current state your diploma work.