Investment Management Impact on performance managers Presenter: Mark Heath B.Bus CPA MAIPM Office: Mobile:

Strategic value How much is it worth? Strategic value Future Options Option Pricing ==

Management options Hold? Sell? Buy? Maintain current project / business Abandon project / business Invest in project / business

Valuation methods NPV Payback Option Pricing Good for non-strategic decisions Complete waste of time Only method that values all 3 options

Financial options Hold? Sell? Buy? In the money call option Put option Call option (American with dividends)

Implementing option pricing Stage gate financing Value 3 options Track 3 options

PLANACCOMPLISH SOFTHARD Increasing probability of success TIME PHASE 1 CONCEPT PHASE 2 DEVELOPMENT PHASE 3 IMPLEMENTATION PHASE 4 TERMINATION Stage Gate Finance Business Case Positional Paper Scope of Work Change Control Benefits Realisation

Information required Asset price or share price Exercise price Standard deviation of forecast Amount of time till next stage gate Risk free rate of return

Define value / cost drivers Estimate project costs Estimate discount rate Net present value analysis

Utilise NPV analysis Carry out sensitivity analysis Track project costs Track value / cost drivers

Sensitivity Analysis Best and worst case Monte Carlo simulation Probabilities of each case

Monte Carlo Simulation Mean NPV Std. Dev. Upper and lower limits

Option pricing – information at hand PV of cash flows = Asset value or share price Initial Investment = Exercise Price Monte Carlo Simulation = Standard deviation Time till next stage gate = time till exercise of option 90 bank bill rate = Risk free rate

Option pricing methods Black - Scholes Binomial method Easy to useEasy to use More accurateMore accurate Won’t value America put optionsWon’t value America put options Won’t value American call with dividendsWon’t value American call with dividends Not as accurate unless using weekly periodsNot as accurate unless using weekly periods Can be used for all option typesCan be used for all option types Uses decision tree analysisUses decision tree analysis Sets up benefits tracking modelSets up benefits tracking model

Binomial Method Needed for abandon and hold options because of dividends and early exercise Decision tree analysis with option pricing theory Start at end of project’s life and work backwards

Binomial method Ex = Cost of investment in project A = base case NPV d = % change in NPV of downside event u = % change in NPV of upside event B = A x d, C = A x u, E = B x d, F = B x u, G = C x d, H = C x u Option value at E – H (opt 2yr) = Letter – Ex Probability of upside event (P) = (rf – d)/ (u-d) Option value at C = (P x H + (1-P) x G)/ (1+rf) t Now Year 1 Year 2

British Telecom – 3G investment Exercise Price = 1bn 10bn initial investment to get option PV of future cash flows = 6bn NPV = -5bn Standard deviation = 150% Risk free rate =.04 Time to exercise = 5 years Value of option = 5.2bn

Tangible v intangible assets

NAB investment in Homeside $A 2.2bn Investment Income stream of avg $A170m / year PV of income stream $A2.2bn Value of options into US allows for positive NPV Revaluation of MSR’s through derivatives trading causes losses

Revaluation of MSR’s

HIH investment in FAI Cost of Investment = $320m Base case NPV = -$16m NPV range = -$85m and $18m Call option value = $13m Put option value = $30m First decision tree point puts -$105m

Implications for the performance manager Benefits management is as important as other job functions Binomial method and decision tree analysis provides framework Should be embedded in weekly reporting