real options in practice

[...]... decision-making procedures The future may show that failure or success in identifying, analyzing, and executing real options is to a large extent driven by organizational design The use of real option analysis in the appraisal is not about getting bigger numbers for your projects, nor is it per se about encouraging investments 12 REAL OPTIONS IN PRACTICE early, when NPV suggests refraining from investment Real. .. an Idea 15 on the assets of the firm.11 In fact, it was Stewart Myers12 who pioneered the concept that financial investments generate real options and also coined the term real options in 1977 Stewart Myers argued that valuation of financial investment opportunities using the traditional DCF approach ignores the value of options arising in uncertain and risky investment projects A decade later Myers... application in financial markets In 1975, other exchanges began offering call options and, since 1977, put options have also been traded Today, exchanges in a multitude of countries that cover more than 95% of the world equity market offer stock index options At the same time that financial options began trading, academic researchers also started viewing corporate securities as either call or put options Real. .. distinct in real options versus financial options We will discuss some of the fundamental differences in the next chapter The Black-Scholes pricing method of financial options assumes a lognormal distribution of future returns in a continuous time framework A diffusion process refers to continuous, smooth arrival of information that causes continuous price changes with either constant or changing variance... (NPV) is catching on with more and more senior finance executives.” R Fink CFO.com, September 2001 In ten years, real options will replace NPV as the central paradigm for investment decisions.” Tom Copeland & Vladimir Antikarov Real Options, A Practitioner’s Guide, 2001 “Information for evaluating real options is costly or unavailable, and asking for more money later is difficult and may be interpreted... growth options by introducing irreversibility into the equation While this is a key feature of all investment decisions, the NPV rule fails to recognize irreversibility as a cost, the opportunity cost of the money being invested, and the cost of giving up flexibility by committing resources irreversibly Correspondingly, there must then be a value in keeping options open, that is, not exercising options, ... possibly uncovering new real options Real option analysis should assist an organization in coping with uncertainty, which becomes contained within more certain and defined boundaries, the option space The commitment of organizational resources to uncertainty becomes limited in extent and time and becomes visibly staged Real option analysis helps the organization to comprehend how uncertainties impact... expectations set in the real option analysis Real Option—The Evolution of an Idea 13 and reflected in the real option price, the organization has to do a postmortem to uncover where and why the three components got misaligned— to avoid similar mistakes in the future THE HISTORY OF REAL OPTIONS The trade of options on real assets is older than transactions involving money In 1728 B.C., Joseph was sold into Egypt... the Pharaoh that he invest heavily in grain after learning about the Pharaoh’s dreams Joseph recognized this to be the best path into the future: exercising the option and buying all available grain now and during the coming seven productive years in order to save it for the seven years of famine The risk Joseph and his contemporaries faced in Egypt was to die of starvation; the real option available... options, or in delaying the exercise until further information has arrived and uncertainty has been resolved Dixit and Pindyck further elaborated this concept in their seminal book on the subject entitled Investment Under Uncertainty.20 The title originally proposed was “The real option approach to investment.” Shortly thereafter, in 1996, Trigeorgis21 published a comprehensive review of the real option . and possibly uncovering new real options. Real option analysis should assist an organization in coping with uncertainty, which becomes contained within more certain and defined boundaries, the. often it comes in se- quential steps with various decision points, including “go” and “no-go” 2 REAL OPTIONS IN PRACTICE alternatives. All of these choices are real managerial options and impact. value in determining the real option value—as there is no real option. The option approach integrates managerial flexibility in the valuation by assuming that at each stage in the future, pending