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Investment Under Uncertainty in Information Technology: Acquisition and Development Projects

Author

Listed:
  • Eduardo S. Schwartz

    () (Anderson Graduate School of Management, University of California--Los Angeles, Los Angeles, California 90095-1481)

  • Carlos Zozaya-Gorostiza

    () (Instituto Tecnológico Autónomo de México, Río Hondo #1, México D.F. 01000, México)

Abstract

In this paper, we develop two models for the valuation of information technology (IT) investment projects using the real options approach. The IT investment projects discussed in this paper are categorized into development and acquisition projects, depending upon the time it takes to start benefiting from the IT asset once the decision to invest has been taken. The models account for uncertainty both in the costs and benefits associated with the investment opportunity. Our stochastic cost function for IT development projects incorporates the technical and input cost uncertainties of Pindyck's model (1993), but also considers the fact that the investment costs of some IT projects might change even if no investment takes place. In contrast to other models in the real options literature in which benefits are summarized in the underlying asset value, our model for IT acquisition projects represents these benefits as a stream of stochastic cash flows.

Suggested Citation

  • Eduardo S. Schwartz & Carlos Zozaya-Gorostiza, 2003. "Investment Under Uncertainty in Information Technology: Acquisition and Development Projects," Management Science, INFORMS, vol. 49(1), pages 57-70, January.
  • Handle: RePEc:inm:ormnsc:v:49:y:2003:i:1:p:57-70
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    File URL: http://dx.doi.org/10.1287/mnsc.49.1.57.12753
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    References listed on IDEAS

    as
    1. Pindyck, Robert S., 1993. "Investments of uncertain cost," Journal of Financial Economics, Elsevier, vol. 34(1), pages 53-76, August.
    2. Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1992. "Waiting to Invest: Investment and Uncertainty," The Journal of Business, University of Chicago Press, vol. 65(1), pages 1-29, January.
    3. Kumar, Ram L., 1999. "Understanding DSS value: an options perspective," Omega, Elsevier, vol. 27(3), pages 295-304, June.
    4. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-157, April.
    5. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, Oxford University Press, vol. 101(4), pages 707-727.
    6. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    7. Panayi, Sylvia & Trigeorgis, Lenos, 1998. "Multi-stage Real Options: The Cases of Information Technology Infrastructure and International Bank Expansion," The Quarterly Review of Economics and Finance, Elsevier, vol. 38(3, Part 2), pages 675-692.
    8. Margrabe, William, 1978. "The Value of an Option to Exchange One Asset for Another," Journal of Finance, American Finance Association, vol. 33(1), pages 177-186, March.
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