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Profitability, balance sheet data, real options and the valuation of equity

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Abstract

We illustrate the impact that real options generally available to firms can have on the value of corporate equity, and in particular the valuation errors that are likely to arise from ignoring them. Moreover, we develop real option values in terms of the profitability and balance sheet (bookkeeping) measures that appear on published corporate financial statements. Our analysis is conducted in terms of two of the more generally understood real options available to firms; namely, the option to liquidate (or abandon) a firm’s current productive activities and the option to implement (or delay) the unexploited but potentially profitable capital projects that are available to it.

Suggested Citation

  • Herbert, Ian & Shinozawa, Yoshikatsu & Tippett, Mark, 2008. "Profitability, balance sheet data, real options and the valuation of equity," Journal of Financial Transformation, Capco Institute, vol. 22, pages 195-201.
  • Handle: RePEc:ris:jofitr:0846
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    Keywords

    cash flow; cost of capital; equity; real options;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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