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THE PROMISE OF REAL OPTIONS
Author(s) -
Damodaran Aswath
Publication year - 2000
Publication title -
journal of applied corporate finance
Language(s) - English
Resource type - Journals
eISSN - 1745-6622
pISSN - 1078-1196
DOI - 10.1111/j.1745-6622.2000.tb00052.x
Subject(s) - discounted cash flow , valuation of options , cash flow , value (mathematics) , asian option , option value , economics , business , exotic option , actuarial science , financial economics , finance , microeconomics , computer science , machine learning , incentive
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.