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The Promise Of Real Options

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  • Aswath Damodaran
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    Abstract

    In recent years, both practitioners and academics have argued that traditional discounted cash flow models do a poor job of capturing the value of the options embedded in many corporate actions. This paper shows how option pricing models used in valuing financial assets can be used to value three kinds of real options that are often built into corporate projects: the option to delay, the option to expand, and the option to abandon. As a number of examples in this paper suggest, corporate investments that would be rejected using conventional DCF analysis can sometimes be justified by the value of the strategic options they provide. As the illustrations also show, however, the pricing of real options is considerably more difficult than the pricing of financial options and adjustments must often be made to capture the complexity of real investments. 2000 Morgan Stanley.

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    Bibliographic Info

    Article provided by Morgan Stanley in its journal Journal of Applied Corporate Finance.

    Volume (Year): 13 (2000)
    Issue (Month): 2 ()
    Pages: 29-44

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    Handle: RePEc:bla:jacrfn:v:13:y:2000:i:2:p:29-44

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    Cited by:
    1. repec:ebl:ecbull:v:4:y:2005:i:3:p:1-10 is not listed on IDEAS
    2. Sinha, Pankaj & Mudgal, Hemant, 2011. "Valuation of 3G spectrum license in India: A real option approach," MPRA Paper 31281, University Library of Munich, Germany.
    3. Fernández, Pablo, 2002. "Valuing real options: frequently made errors," IESE Research Papers D/455, IESE Business School.
    4. Sinha, Pankaj & Sathiyanarayanan, Nataraj, 2012. "Valuation of 2G spectrum in India- A real option approach," MPRA Paper 40470, University Library of Munich, Germany.
    5. Akalu, M.M. & Turner, J.R., 2002. "Investment Appraisal Process in the Banking & Finance Industry," ERIM Report Series Research in Management ERS-2002-17-ORG, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni.
    6. Marcello Basili & Fulvio Fontini, 2005. "Quasi-option value under ambiguity," Economics Bulletin, AccessEcon, vol. 4(3), pages 1-10.

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