Laura Martin: Real Options and the Cable Industry Harvard Case Solution & Analysis

Ke = Rfr + Beta (Rm -  Rfr)

The WACC for the terminal value used as 9.30% and the growth rate was incorporated in the terminal value was 3%. The revised calculation was also made on the basis of the implied growth rate calculated for the EBITDA growth. The implied growth rate was 14.6%, furthermore the depreciation and amortization was calculated earlier separately. The deprecation in the discounted cash flow followed the decline in future and started from the year 2001 till 2008 with rate of 2%. The amortization also reflected the decline with 2% rate from 2001 till 2008 and it also showed the tax shield impact on it. For the equity valuation the present value of unlevered cash flows were deducted from the terminal value impacted out from the present value. This present value of terminal value was calculated using the WACC rate or discounted rate. The next step was the deduction of debt portion from the terminal value of equity with addition of cash at hand along with non-consolidated assets and other assets. The value appeared as it was discounted value of equity which then further proceeded with dividing the number of share and came out as the target price of per share. Earlier, Martin calculated it as $37.5 per share for the Cox Communications.

Real Options Valuation Analysis:

Through utilization of the Black Scholes Model for determining the value of the European style call option, there are few inputs which are required. To begin with, the present value of the stealth tier needs to be calculated. The cost of acquisition for this project or strike price is an alternate important input. Particular for this case, strike price is characterized as the spending with the Stealth Tier, which is recognized as the opportunity cost of not acquiring the call option. Secondly, the volatility is computed along with the life of the cable plant (time) and an investment rate. Apparently, this technique incorporates the value of the "stealth tier" and gives in a much higher value than afore mentioned approaches.

The stealth tier is similar to a call option in light of the fact that it gives the right to utilize it yet it is not the obligation for those who hold it. When it comes to the valuation of the bandwidth, the cost of bandwidth surpasses the cost of the stealth tier; this will result in the technological advancement. On the other hand, if this cost exceeds then the option holder will not excise it; which means that the only cost will be the option cost which is also known as the option premium cost. Laura Martin uses the Black- Scholes Model for the valuation of the stealth tier; which comprises the five variables in it. The variables that are included in the Black-Scholes Model are; stock price, exercise price, time to exercise the option, the variation and the risk free rate. These variables are the significant components that differentiate the option instrument from the other instrument. It gives the right to the holder of this instrument either to exercise to seek the opportunity for the profit maximization or to avoid it for the uncertainty regarding the underlying asset of this instrument. By using the Black-Scholes Model for the stealth tier, the resulted value is reasonable. It is because the option creator and the option holder both decide the value of the option on the basis of given market data and the conditions with respect to the uncertain outcome. The Martin’s choice of the volatility is 25% which is the reasonable variance choice. If it will be 50% then the value of the option will be changed with respect to the uncertain event, and that event will also compromise the value of the per home market value..........................................

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