This paper calculates the value of the firms using an option pricing model. Two firms having different sales growth rates were used as an example - one with a constant growth rate and the other a growth stage firm. Calculating the free cash flows from sales, I used trinomial lattice framework suggested by Boyle(1988) for the valuation of the constant growth rate firm. In applying the framework, complex real options with many different options were decomposed into a set of simple options, and the value has been calculated for each option. Additionally, the deviation from the value additivity due to the interaction was taken into account.
For the growth stage firm, I assumed that the sales growth rate has a mean-reversion process. This paper adopted Hull and White’s single factor model(1993) in implementing the process of mean-reversion growth rate. This approach is alternative to the Monte Carlo simulation used by Schwartz(2000). For adding a new business, Hull and White’s two factor model(1994) was used to consider the correlation between the two businesses. The trade-off of choosing the valuation method between risk-neutral and real process has been discussed also at the end.
