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Valuation of Information Technology Investments as Real Options

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  • Schwartz, Eduardo S.
  • Zozaya-Gorostiza, Carlos

Abstract

This article describes a methodology for evaluating information technology investments using the real options approach. IT investment projects 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. A couple of models that account for uncertainty both in the costs and benefits associated with the investment opportunity are proposed for these project types. 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

  • Schwartz, Eduardo S. & Zozaya-Gorostiza, Carlos, 2000. "Valuation of Information Technology Investments as Real Options," University of California at Los Angeles, Anderson Graduate School of Management qt4dv270zv, Anderson Graduate School of Management, UCLA.
    • Handle: RePEc:cdl:anderf:qt4dv270zv
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    Citations

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    Cited by:

    1. Beatriz Mota Aragón, 2011. "Capital Investments and Real Options: New Proposals," Revista de Administración, Finanzas y Economía (Journal of Management, Finance and Economics), Tecnológico de Monterrey, Campus Ciudad de México, vol. 5(1), pages 65-76.
    2. Didier Cossin & Benoît Leleux & Entela Saliasi, 2002. "Understanding the Economic Value of Legal Covenants in Investment Contracts: A Real-Options Approach to Venture Equity Contracts," Swiss Finance Institute Research Paper Series rp63, Swiss Finance Institute.
    3. Philipp N. Baecker, 2007. "Real Options and Intellectual Property," Lecture Notes in Economics and Mathematical Systems, Springer, number 978-3-540-48264-2, December.
    4. Han T.J. Smit & Lenos Trigeorgis, 2006. "Real options and games: Competition, alliances and other applications of valuation and strategy," Review of Financial Economics, John Wiley & Sons, vol. 15(2), pages 95-112.
    5. Ángel León & Diego Piñeiro, 2004. "Valuation of a Biotech Company: A Real Options Approach," Working Papers wp2004_0420, CEMFI.
    6. Marcel Boyer & Éric Gravel, 2003. "Real Options at Bell Canada," CIRANO Project Reports 2003rp-01, CIRANO.
    7. Roberto J. Santillán Salgado, 2004. "Application Of The Real Options Methodology To Value A Cement Firm'S Acquisition," Remef - Revista Mexicana de Economía y Finanzas Nueva Época REMEF (The Mexican Journal of Economics and Finance), Instituto Mexicano de Ejecutivos de Finanzas, IMEF, vol. 3(4), pages 313-331, Diciembre.
    8. Smit, Han T.J. & Trigeorgis, Lenos, 2006. "Real options and games: Competition, alliances and other applications of valuation and strategy," Review of Financial Economics, Elsevier, vol. 15(2), pages 95-112.
    9. Lukas Auer, 2013. "SOA investment decision-making using real options analysis," International Journal of Services, Economics and Management, Inderscience Enterprises Ltd, vol. 5(1/2), pages 21-40.

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