Introduction to Real Options

Alexander Vollert
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Alexander Vollert: Universität Karlsruhe (TH)

Chapter 2 in A Stochastic Control Framework for Real Options in Strategic Evaluation, 2003, pp 7-45 from Springer

Abstract: Abstract This section gives an overview of the basic ideas of the real option approach to capital budgeting in firms. It deals with the importance of recognizing flexibility in capital investments, and how traditional ways of valuing investments have largely neglected the benefits of flexibility in the presence of uncertainty and irreversibility. Flexibility in investment decision making can limit the downside potential of an investment while exploiting its upside potential. In its asymmetric structure, it is shown that flexibility possesses option-like features that allow for interpreting managerial flexibility as options on real assets which can be valued using option pricing methods well known in financial markets. The resulting additional value introduced by flexibility can be operationalized by the notion of expanded net present value, which covers the sources of value coming from the (static) project without flexibility and the value of all relevant managerial real options.

Keywords: Cash Flow; Option Price; Real Option; Investment Project; Underlying Asset (search for similar items in EconPapers)
Date: 2003
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Persistent link: https://EconPapers.repec.org/RePEc:spr:sprchp:978-1-4612-2068-8_2

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DOI: 10.1007/978-1-4612-2068-8_2

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