Case Study of Evaluation of whether Ed’s Samples †MyAssignmenthelp.co

Question: Discuss about the Evaluation of whether Eds case might be helped by a real option and the way it could help. Answer: Based on the provided case study, Airway Technologies has an engineering manager named Ed Draycutt. The organisation is engaged to produce computer systems for control installations related to air traffic in the airports. In order to deal with this situation, real option could be useful to evaluate the feasibility of the project. In the words of Burns Walker (2015), real option is the alternative available within the opportunities of business investment, as it references a tangible asset rather than financial instruments. Hence, with the help of real option, Airway Technologies could change or curtail project depending on the changing market conditions. In addition, factoring in real options influences the potential investment valuations (Grob, 2013). As real options do not take into account derivative financial instrument; however, it provides real choices or opportunities, which Airway Technologies could seek or exploit opportunity. For instance, investment in a new system might fetch an organisation with new opportunities of initiating new products and making adjustments to the changing conditions in the market (Bierman Jr Smidt, 2012). Hence, in order to undertake the investment decision, Airway Technologies needs to take into account the value of the real option that the facility provides. In this case, the use of abandonment option could be made, as it permits both parties to walk out of the contract before the fulfilment of obligations (Brunzell, Liljeblom Vaihekoski, 2013). Airway Technologies could include this option explicitly as portion of the terms of contract along with specifying that there would not be any penalty imposed on any the parties, if the contract was terminated before maturity. For instance, if Ed Draycutt withdraws providing his proposed system having a clause of abandonment, Airway Technology could not sue him for violating the terms of the contract. Thus, this option of abandonment is an attractive characteristic for the participants, as it helps in protecting the financial interest of each party in the circumstance that an investment does not generate the desired benefits. However, both Airway Technology and Ed Draycutt need to be aware that if any party withdraws the contract, it could have serious repercussions on the other party. It has already been observed that there is a substantial risk of loss associated with the project. It is required to be made explicit in any management presentation. The option of abandonment would be highly significant for the organisation, if a considerable portion of the developmental cost could be avoided or recovered in the initial year. Hence, it would seem like the proposed system might not be installed. Due to thus, the magnitude of loss could be reduced; however, this might have considerable effect on the overall productivity and profitability of Airway Technologies. Therefore, it is highly suggested that the organisation need to make use of the clause of abandonment, since changing market conditions might necessitate the requirement for stopping the installation of the new system to avoid serious losses. References: Bierman Jr, H., Smidt, S. (2012).The capital budgeting decision: economic analysis of investment projects. Routledge. Brunzell, T., Liljeblom, E., Vaihekoski, M. (2013). Determinants of capital budgeting methods and hurdle rates in Nordic firms.Accounting Finance,53(1), 85-110. Burns, R., Walker, J. (2015). Capital budgeting surveys: the future is now. Grob, H. L. (2013).Capital budgeting with financial plans: an introduction. Springer-Verlag.