An expansion option is an investment that helps businesses take advantage of unexpected expansion opportunities. It can be used to offset costs and is often secured at the time of purchasing a real option. It can be used in various situations, such as expanding production or allowing tenants to expand their stores. It allows businesses to expand beyond their original plans and generate higher profits while keeping expenses low.
An expansion option is a type of investment that can be secured to help businesses take advantage of expansion opportunities that may arise in connection with a particular project. The idea behind the option is to help offset the costs associated with choosing to go ahead with that expansion at a rate that had not previously been anticipated. This approach can be used in a number of situations ranging from expanding the production rate of a new product that has generated much higher demand than originally anticipated to allowing tenants the ability to expand the size of a store or another retail environment with relative ease if business volume justifies the action.
The guarantee of an expansion option usually occurs at the time the real option associated with the firm is purchased. This type of embedded option remains in effect for the life of that real option and can be used when needed. While adding the expansion option often costs a little more, the extra expense is usually low enough not to cause hardship for the buyer and has the ability to provide significant returns if the investor ever calls the option.
One of the easiest ways to understand how an expansion option works is to consider a small business owner setting up a store on a given block. As part of the deal, the owner secures an expansion option that can be invoked if the business generates considerably more business during that first year of operation than originally anticipated. The option can then be exercised to help the owner secure additional equipment and other necessities which can be used to expand the location, allowing the business to accommodate additional inventory and hopefully continue to increase the number of sales generated each month .
Similarly, the expansion option can also be used by a company that is launching a new product. By having the option in place, the company is able to secure additional raw materials or even more manufacturing equipment if demand for that new product exceeds a certain level, making it necessary to expand manufacturing facilities to keep up with that demand. . Without this type of option in place, the cost of expansion could be somewhat prohibitive, prompting the company to delay expansion and consequently miss out on potential sales. As a means of hedging on a new opportunity, the expansion option allows the owner to take advantage of opportunities to expand a project beyond the original plans and ultimately generate a considerably higher profit from the business, while keeping expenses as low as possible .
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