Expansion Option

AAA

DEFINITION of 'Expansion Option'

An embedded option that allows the firm which purchased the real option to expand its operations in the future at little or no cost. An expansion option, unlike typical options which obtain their value from an underlying security, receives its worth from the flexibility it provides to a company. Once the initial stage of a capital project has been implemented, an expansion option holder can decide whether to move forward with the project.


In terms of real estate, expansion options provide tenants with the choice to add more space to their living premises.

INVESTOPEDIA EXPLAINS 'Expansion Option'

For example, if a company is unsure as to whether or not its newly introduced product will be successful in the market, it can purchase an expansion option. The expansion option will allow the firm to assess the economic environment in the future and determine whether it is profitable to continue developing the particular product. If the firm initially expected to produce 1,000 units five years, exercising the expansion option would let them purchase additional equipment to increase capacity for a price which is below market value. If economic conditions are good and expansion is desirable, the option will be exercised. Otherwise, the expansion option expires.

RELATED TERMS
  1. Net Present Value - NPV

    The difference between the present value of cash inflows and ...
  2. Barrier Option

    A type of option whose payoff depends on whether or not the underlying ...
  3. Corporate Finance

    1) The financial activities related to running a corporation. ...
  4. Expansion

    The phase of the business cycle when the economy moves from a ...
  5. Real Option

    An alternative or choice that becomes available with a business ...
  6. Risk

    The chance that an investment's actual return will be different ...
RELATED FAQS
  1. How can I create a yield curve in Excel?

    You can create a yield curve in Microsoft Excel if you are given the time to maturities of bonds and their respective yields ... Read Full Answer >>
  2. What are the different formations of yield curves?

    There are three main different formations of yield curves: normal, inverted and flat yield curves. The yield curve describes ... Read Full Answer >>
  3. What does a large multiplier effect signify?

    The multiplier effect depends on banks' reserve requirements. In macroeconomics, if a country exhibits a large multiplier ... Read Full Answer >>
  4. How does quantifying fixed overhead volume variance show whether a company is profitable ...

    Fixed overhead volume cannot definitively prove a company is profitable, but it can be used to provide an excellent indication ... Read Full Answer >>
  5. What is the criteria for a simple random sample?

    Simple random sampling is the most basic form of sampling and can be a component of more precise, more complex sampling methods. ... Read Full Answer >>
  6. How is money supply used in monetary policy?

    Regulating the money supply is the sole tool of the Federal Reserve's monetary policy. The Federal Reserve can affect the ... Read Full Answer >>
Related Articles
  1. Investing

    Using DCF In Biotech Valuation

    Valuing firms in this sector can seem like a black art, but there is a systematic way to pin a price on potential.
  2. Forex Education

    Time Value Of Money: Determining Your Future Worth

    Determining monthly contributions to college funds, retirement plans or savings is easy with this calculation.
  3. Markets

    Intangible Assets Provide Real Value To Stocks

    Intangible assets don't appear on balance sheets, but they're crucial to judging a company's value.
  4. Economics

    Explaining the Cash Budget

    A cash budget is a plan for the inflows and outflows of cash for a business or an individual.
  5. Budgeting

    10 Worst And Best Vacation Cities In The U.S.

    The many costs of planning a vacation will put a stress on most people’s finances, but where you choose to go can be what really makes your travel budget.
  6. Investing

    Why Some Investors Are Tilting Toward TIPS

    Last month’s five-year TIPS auction drew nearly $48 billion in interest, a sign of recent renewed demand for this inflation indexed asset among investors.
  7. Economics

    What is the International Monetary Fund?

    The International Monetary Fund fosters global monetary cooperation and sustainable economic growth.
  8. Investing

    What More Volatility Means For Momentum Stocks

    One byproduct of the recent tick higher in bond yields: a meaningful rise in volatility for both stocks and bonds.
  9. Economics

    What To Expect Following The Tory Triumph

    The decisive Conservative victory in the UK's recent general election removes some of the near-term political uncertainty that many were anticipating.
  10. Economics

    The Pros & Cons of a Trade Deficit

    Is a trade deficit, also known as a current account deficit, beneficial or detrimental to a country's economy?

You May Also Like

Hot Definitions
  1. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  2. Productivity

    An economic measure of output per unit of input. Inputs include labor and capital, while output is typically measured in ...
  3. Variance

    The spread between numbers in a data set, measuring Variance is calculated by taking the differences between each number ...
  4. Terminal Value - TV

    The value of a bond at maturity, or of an asset at a specified, future valuation date, taking into account factors such as ...
  5. Rule Of 70

    A way to estimate the number of years it takes for a certain variable to double. The rule of 70 states that in order to estimate ...
  6. Risk Premium

    The return in excess of the risk-free rate of return that an investment is expected to yield. An asset's risk premium is ...
Trading Center