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Both the strategic Real-Options are American call options, both certainly driven by private risks and perhaps by some market risks as well. The strategic Real-Option to set up a greenfield position in Asia will however be somewhat more riskier as there is almost none experience in this market. The risks applicable to these options will therefore be almost identical. For the valuation of the strategic Real-Options, we should first check whether we could structure these options as compound options. In example 3 in section 2.1.5, we showed how to do this for investments related to an upgrade to a company’s information system. It appears that the necessary investments could be divided over three stages, each with another risk type. This had two advantages, first after each stage we could choose to delay or to stop with further investments and second, we could separate risks.

Both strategic Real-Options are related to an expansion of production facilities. Additional production facilities will however always require more clients, hence investments in Bucket’s sales force. If Bucket is able to successfully target these new markets, sales will increase steadily and will not adjust immediately to their full capacity. Bucket will therefore benefit from a production location that could increase in capacity in line with the expected sales growth. If this is possible, the investments of Bucket could be split up and comprises:

• An investment in a production location that is suited to produce a certain amount X, which is expected to be offset in Y years, plus an investment in the necessary assets to produce the required amount for the first Y year(s).

• One, two or more expansion investments in assets to increase the production capacity of the plant to ultimately the location’s maximum capacity.

The initial investment is the riskiest, the risks that are related to it are related to either the demand to Bucket’s products and their market price or to the cost of the plant and the costs related to production. In more detail1_:

• Demand

– Sales force. The success/capacities of the sales force influences how many new clients could be attracted per month and whether long-term client relationships could be established. Fur- thermore, the average volume of the attracted clients is important. Before Bucket starts to invest, early agreements with clients can be essential. The signing of pre-contracts will solve lots of uncertainty.

– Competition. Bucket will mix itself in an existing market. If competition is intense and they offer comparable products, it will be difficult for Bucket to create demand for their products.

• Market price

– Competition. The price Bucket could ask for their products is also influenced by competition. As the price determines the margin Bucket could realise on their sales, it will be of great influence to the final decision of executing the Real-Option. Furthermore, the intensity of competition will also influence whether Bucket could increase its price when its cost price increases.

• Production plant

– Initial investment costs. The costs of investment are very important to the decision of exe- cuting the Real-Option. However, these do not have to be risky as it should be possible to estimate these well up-front and even to come to some early agreements about the possible costs.

• Production

– Cost price. The cost price will comprise the costs of raw materials, production costs per product and overhead costs per product. The costs of raw materials may vary and could therefore lead to (high) volatility in the cost price. Because the cost price is very important to the margin on Bucket’s products, volatility in the cost price may be very risky.

– Errors. Failures in production may lead to significant additional costs. When putting into use a new production plant, there is an increased risk of failure in production, which may lead to a lower production efficiency and therefore to higher production cost per product.

The presence of competition appears to be very important to the evaluation of Bucket’s strategic Real- Options. Just like with the initial investment costs, Bucket could map the competitive environment up-front and should therefore be able to make reasonable estimates for the sales volume that should be reached with their sales force and the price they could ask. Risks related to demand are therefore mainly subject to the success of Bucket’s sales force. Risks related to the market price are related to the possibility of Bucket to increase the price when the costs of raw materials increase. The initial investment costs don’t have to be risky, but production costs are. The production cost per product may vary due to relatively many errors in the beginning. Most important to the risks related to the production is however the volatility in the price of raw materials. According to Rabobank (2012), the cost of raw materials could be influenced mainly by market risks.

The expansion investments are less risky, as many private risks will be either resolved or less volatile. After a solid client base is established, bringing in new clients is less important and risks related to demand are increasingly more driven by the performance of established clients (hence, could become market risk). The risks related to the market price will almost be fully resolved, as experience and agreements will make clear to Bucket if it is possible for them to increase their price to maintain gross margins. The investment costs for the expansion are also not risky, as these could be determined up-front

1_{General risk types are not included in the analysis, as for example organisational risks (e.g. culture, the presence of} qualified personnel), political risks, etc..

(even better than for the initial investment due to experience with local contractors). Meanwhile, the effective production rate of the factory is known, expansion investments are not expected to really change this, hence this risk is also resolved. The volatility in the cost of raw materials will stay an important risk factor.

It is unclear whether it would be a possibility for Bucket to invest in stages in one of the strategic opportunities. Our analysis shows however that it would be very useful for Bucket to leave room for at least one expansion investment. First, this decreases the initial investment amount and therefore probably increases the profitability in the first stage and second, the risks applicable to the first investment either resolve or turn (partly) into market risk. We therefore conclude that both strategic Real-Options should be seen as compound American call options, where the first option is driven mainly by private risks, but the next option will be dominated by market risks.