Principles of Corporate Finance_ 12th Edition

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584 Part Six Options


bre44380_ch22_573-596.indd 584 09/30/15 12:08 PM


◗ FIGURE 22.5
In the U.K. electricity prices
are set every half hour. The
top panel is a histogram of
prices (£/MWH) for January
2013 through January 2015.
Note how the histogram is
skewed to the right. Many
prices exceeded £100/MWH
and a few (not visible in the
plot) exceeded £300/MWH.
The bottom panel shows the
payoff to a plant that costs
£60/MWH to run. The plant
operator has an option to
produce with an exercise
price of £60.

Price per megawatt hour, £

0

500

1,000

1,500

2,000

2,500

(^0102030405060708090)
100110120130140150160170180190200210220230240250260
Number of half-hour periods
0
500
1,000
1,500
2,000
2,500
(^0102030405060708090)
100110120130140150160170180190200210220230240250260
Number of half-hour periods
Price per megawatt hour, £
Payoff to operating
plant = price – £60
in computer-controlled knitting machines, which allow production to shift from product to
product, or from design to design, as demand and fashion dictate.
Flexibility in procurement can also have option value. For example, a computer manufac-
turer planning next year’s production must also plan to buy components, such as disk drives
and microprocessors, in large quantities. Should it strike a deal today with the component
manufacturer? This locks in the quantity, price, and delivery dates. But it also gives up flex-
ibility, for example, the ability to switch suppliers next year or buy at a “spot” price if next
year’s prices are lower.
For example, Hewlett Packard used to customize printers for foreign markets and then
ship the finished printers. If it did not correctly forecast demand, it was liable to end up with
too many printers designed for the German market (say) and too few for the French market.
The company’s solution was to ship printers that were only partially assembled and then to

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