Real option Analysis Applied on Product Development A Case Study of Digital Illusuion CE AB (Publ)

Abstract

Abstract Increase in globalization, improvements of capital markets and easier access to financing indicate that the wave of initial public offerings such as IT, consulting and human capital firms is changing the nature of the firm. This change in turn also affects the capital structure, corporate governance, valuation models and accounting techniques, therefore it has become necessary to re-examine much of what is taken for granted within corporate finance. More precisely it leads us to reconsider what entity is being financed, governed and valued. Accordingly, the inefficiency when applying traditional analytical procedures forces decision makers to rely on new valuation methods, in which flexible investment decisions and managerial flexibility are considered as well as risk and uncertainty.

Bearing this in mind we find it interesting to practice the Real Option Analysis on product development through valuing a new type of firm, a web of specific investments. Digital Illusion CE AB a Swedish IT company that is listed on the New Market with focus on game development is therefore chosen for this case study.

Accordingly the main purpose of this thesis is to implement ROA on product development. This study will also lead us to analyse the changes in the overall value of the firm, which is derived from product development. Further an analysis of EA’s bid on Dice’s shares will also be conducted. We aim to accomplish this by applying company valuation theories into practice, after which we will analyze the advantages and draw backs of the valuation methods, DCF and ROA that are exercised during this report.

The report has led us to conclude that ROA can price the projects within a firm individually and that it in turn completes the value of a firm with option values, considering the uncertainty and flexibility. In contrast to this the DCF is more straightforward to apply on company valuation, but it does however give an overall picture of the firm value without considering the project’s flexibility and uncertainty individually.

After our calculations we have come to the conclusion that from a ROA point of view Dice is undervalued on the stock market and with a DCF valuation Dice is priced more reasonably by the market. Thus EA made a well-considered acquisition of 62 percent of Dice shares at a tender offer of SEK 61, but nevertheless we can state that Dice has been valued on the Swedish Stock Market by analysts who were using the DCF valuation, and therefore EA’s tender offer was deemed appropriate.