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On the Valuation of Companies with Growth Opportunities

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Abstract

Each company faces day to day investment opportunities. Just by staying in business the company is taking a decision of reinvesting capital. These opportunities have to be fairly valued to overcome misallocation of resources. A project with high growth opportunities requires high reinvestments to take full advantage of them until it reaches its mature stage. These investments can be seen as a succession of call options on future growth. When a company with such prospects is valued using the discounted cash flow technique and growth is taken implicitly in the growing cash flows and the residual value, the value thus obtained will be higher than the true one (under certain circumstances). Technology advances and the effects of globalization create enormous growth opportunities, and so misvaluation risks are higher.

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File URL: http://www.cema.edu.ar/publicaciones/download/volume6/dapena.pdf
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Article provided by Universidad del CEMA in its journal Journal of Applied Economics.

Volume (Year): VI (2003)
Issue (Month): (May)
Pages: 49-72

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Handle: RePEc:cem:jaecon:v:6:y:2003:n:1:p:49-72

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Keywords: real options; valuation; contingent claims valuation;

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  1. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  2. Constantinides, George M, 1978. "Market Risk Adjustment in Project Valuation," Journal of Finance, American Finance Association, American Finance Association, vol. 33(2), pages 603-16, May.
  3. Nalin Kulatilaka & Alan J. Marcus, 1992. "Project Valuation Under Uncertainty: When Does Dcf Fail?," Journal of Applied Corporate Finance, Morgan Stanley, Morgan Stanley, vol. 5(3), pages 92-100.
  4. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, Elsevier, vol. 5(2), pages 147-175, November.
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