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Real Options. Corporate Finance

Real options refer to the right of the company to perform a certain activity or action at predetermined costs for a specific period. However, It is not an obligation that the company must perform that particular task. With real options, companies can minimize risks associated with new ventures. They can identify possible paths to successful completion of the project. Real options allow companies to alter their paths if their projects are failing. There are different types of real options that businesses can avail. These include real options of growth, expansion, contraction, termination of unprofitable projects, etc. (Ross, Westerfield, & Jaffe, 2013). In this paper, real options of Wal-Mart Stores Inc. are identified and discussed. These real options are selected on the assessment of the company’s retail business.

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The annual report of Wal-Mart Stores Inc. for the year ending 2014 highlighted that the company considered different options for its future business. One of the options considered by the company was related to the expansion of its retail network. The company planned to open between 17 and 22 stores in the year 2015. The expansion plan would improve consumers’ shopping experience by increasing the retail floor space. It would also strengthen the company’s position in the US retail sector (Wal-Mart 2013 Annual Report, 2014). However, there are risks associated with the company’s decision to open new stores in the US. These risks could include a slowdown in the US economy, low consumer spending, low returns from investments, unprofitable stores, etc. These risks could affect the company’s projected cash flows from its new stores and, therefore, the discounted cash flow method (DCF) for determining the project’s NPV could no longer be viable (Ehrhardt & Eugene, 2013).

It could be suggested that the company’s expansion plan was based on the assessment of the current US retail market conditions. There are obvious uncertainties related to the company’s decision to open up new stores. There are risks that the company might not able to deliver the expected return on investment. Therefore, the company has three options related to its expansion plan. These options are (1) to go ahead with the opening of new stores, (2) to open fewer stores than the targeted number, (3) to delay the opening of stores, and (4) to abandon its plan for expansion.

The options could affect capital valuation of the project. Due to uncertainties in the net present value of the project, the company could consider the real options methodology. The company could use a range of discount rates and make projections for different options available for its future expansion plan. The value of Wal-Mart’s expansion project could vary when different real options are considered. For example, by delaying the project, the company could wait for the appropriate time to make an investment in new stores and generate a higher positive NPV. It could be indicated that real options consider two criteria for evaluating different options available to the company. These criteria include hurdle rate and profitability index that the company should achieve. The company could use different discount rates for estimating the outcome of the project options.

Thus, from the discussion it could be inferred that the identified real options are relevant to the investment decision of Wal-Mart Stores, Inc. If the company plans its future expansion on the basis of these real options, then it can overcome or mitigate the related risks.

References

Ehrhardt, Michael C., & Eugene, B. (2013). Corporate finance: A focused approach. Mason, USA: Cengage Learning.

Ross, ‎S.A., Westerfield, R.W., & Jaffe, J‎. (2013). Corporate finance (10th ed.). New York, USA: Mc-Graw Hill.

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Wal-Mart 2013 Annual Report. (2014). Bentonville: Wal-Mart Stores Inc.

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StudyCorgi. (2022, July 10). Real Options. Corporate Finance. Retrieved from https://studycorgi.com/real-options-corporate-finance/

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