The Real Options Approach To Investment Decision Making.

1604 words - 6 pages

1. Real OptionsReal-options analysis is one of the most important ideas of applied corporate finance to be developed in the last 30 years. Real-options analysis gives management the flexibility to address uncertainties, as they're resolved. Conventional capital budgeting fails to account for this flexibility and, moreover, fails to integrate strategic planning. But the real-options methodology goes beyond a simple view of valuation and more closely matches the manner in which businesses operate. Once a project begins, a manager has the choice to defer additional work, abandon it outright, shut it down and restart later, expand it, trim it back, or even switch its strategic purpose.The real-options method has been used in industries like natural resources, energy, and pharmaceuticals, which have a higher degree of uncertainty in business-process investments. For example, in the oil-drilling industry, uncertainties include issues such as what the cost of the leased land will be. How large are the oil reserves? What is the proper price for the lease on the reserve? Questions like these have led to the use of the real-options methodology as an analytical tool to evaluate these investments in business technology.Real options offer another valuable comparison with financial investing: that holding a diverse portfolio of stocks is less risky than owning one stock. Applying this view of offsetting risk to asset/project evaluation allows for the integration of capital budgeting issues with physical assets on the one hand, and the incorporation of decision-tree analysis on the other. Real assets can be evaluated using techniques developed for financial options, such as the Black and Scholes model.2. NPV MethodThe Net Present Value (NPV) has been one of the most common methods used in making investment appraisals. Most financial managers are familiar with the NPV method, which is based on expected cash flows projected over time that are then discounted at the weighted average cost of capital. It is a standard practice to approve projects with positive NPV and reject the projects with value less than zero. The fact that the NPV method only looks at cash flows is its biggest asset and its biggest drawback. The NPV method was flawed even before it was compared to the Real Options method. In the 70's, financial managers who accepted projects at NPV>0 noticed that NPV produced errors, as the approved projects later turned sour. The problem with NPV was, some projects with positive NPV could not be able to generate enough cash to meet the initial investment. However managers learnt from their mistakes and decided to accept projects withNPV = Investment (where present value of future cash flowsshould exceed initial investment)3. Real Options and NPV in practiceNPV fails to model and fails to capture the value of flexibility. The situations where there is a big difference between the two are all situations where the NPV is low relative to the value of the...

Find Another Essay On The Real Options approach to investment decision making.

Will GRADE Approach Facilitate Decision Making in Insufficient Evidence?

2139 words - 9 pages Phase II Study. Systematic review on Insufficient Evidence Research Question Compared with non-GRADE approach (USPSTF approach), is the use of the GRADE Evidence to Recommendation approach to make recommendation in insufficient evidence scenarios more effective in facilitating the process of decision making for guideline developers? Methods Participants Guideline developers would be considered eligible participants. Guideline developers were

Discuss how information systems might be used to support decision making in business and government organizations. Provide examples from real life cases

2255 words - 9 pages giving workers the information necessary to be more effective. There is no standard digital nervous system. Because each business is different, its digital system will reflect its unique needs and structure.There are several types of information systems which is possible to concentrate on the type of support the systems provide (for communication and decision-making). These systems include OAS (office automation systems), collaborative systems, MIS

The Theoretical Rationale For The NPV Approach To Investment Appraisal

1385 words - 6 pages Explain the theoretical rationale for the NPV approach to investment appraisal and compare the strengths and weaknesses of the NPV approach to two other commonly used approaches. One of the key areas of long-term decision-making that firms must tackle is that of investment - the need to commit funds by purchasing land, buildings, machinery, etc., in anticipation of being able to earn an income greater than the funds committed. In order to

The Decision-Making Process

2363 words - 10 pages ” Decisions According to this model, individuals knowingly limit their options to a manageable set and choose the first acceptable alternative without conducting an exhaustive search for alternatives (SagePub, 2008). This model is considered the bounded rationality model of decision making. A significant part of this model is the tendency to satisfice, which refers to accepting the first alternative that meets your minimum criteria. Making Intuitive

The Importance of Critical Thinking to the Decision Making Process

960 words - 4 pages business in important because it helps one recognize the prejudices, false beliefs, and habits that may lead to flawed decisions. Decision Making Effective decision making involves the ability to identify consistently and select the best choice among multiple options. This is true both personally and professionally. For the decision making process one may use a decision making model. A decision making model is an orderly means by which one

Making the right decision to a fulfilling career

757 words - 4 pages these statements actually bothers my mind in which it gives a different approach of viewing how life would be without a good successful career. Sometimes, doubting yourself of making it throughout 4-years of college may occur but the right decision is to always follow instincts and change a fixed mindset to a growth mindset. Almost a year now in college, and seeing a lot of experiences, which includes all the negative comments made by most high

Case Study: Application of Real Options to Energy Investments

2180 words - 9 pages (Kumbaroglu et. al., 2008). Brach (2003) argues that the real options approach measures uncertainty and risk with flexibility. Santos et. al. (2014) propose that ROA considers the volatility associated with the evaluation process as a potential positive factor which adds value to the investment. Table 1 represents methods of assessment used in energy investment projects. Table 1: Assessment Methods used in Energy Investment Projects Source

The Process of Decision Making

1250 words - 5 pages the difference between desired and actual achievements according to their current situation. When a manager diagnose and analyze the problems carefully, a problem can be identified obviously. When individual or the organization make a decision, there is important to take note more irretrievable the solution once appliance; they more concern about the real decision. In addition, the company more do analytical to making a choice by a decision taker

THE PROCESS OF DECISION MAKING

1148 words - 5 pages Introduction Decision making can be defined as "the act of choosing from among alternatives" (Naylor, 1998, p. 339). In the organization, decision making is quite important for the managers to choose the best choice for establishing their goals. Manager will make a rational and logical decision to overcome the issues. As Daft (2010) mentions, there are six important steps in the decision making process which are recognizing the problem

Real Options: Arturo Berhad Should Expand The Business

2218 words - 9 pages undervalued and the company to miss a lot of opportunity that can only be gained if they continue with the project. They added that real options could turn this decision from rejecting the project to accepting the project. With this, comparisons with the qualitative and quantitative factors come in. It all depends on the individual to make decision whether or not the investment is perceived as a good investment or otherwise an unprofitable

Applying Decision Making Techniques to Identify Solutions

993 words - 4 pages on a list. This technique is also known as importance weighting. This group technique or group think could be used for a more detailed approach to generate, clarify, and evaluate a long list of ideas, problems, or issues in order to effectively prioritize the items on this list. The South Pacific Logistics and Transportation Company can also use this consensus style decision making so that the entire group can reduce the list of ideas to a minimum

Similar Essays

Feminist Approach To Moral Decision Making

1475 words - 6 pages Feminist Approach to Moral Decision Making While ethics theories often focus on justice, care, an "equally valid moral perspective," is usually disregarded because of male bias (Sterba, p. 52). The two perspectives are often harmonious, but a need for care point of view precedence exists. While truth is evident in both these statements, the problem of distinguishing between them becomes apparent soon after. Many feminist look to

Effective Leadership, Ethics In Decision Making, And The Systems Approach

1138 words - 5 pages , ethics in decision making, and the systems approach. Effective Leader in a Learning Organization The leader within the learning organization must be able to make distinctions between their authority and the need for learning (Laurie & Heifetz, 2003). The leaders in the organization must be able to make adaptations and admit they do not know all of the answers, but instead are willing to work with the other employees or members of the organization

Vulnerability Of Evapotranspiration To Urbanisation: A Multi Criteria Decision Making And Artificial Neural Network Approach

1450 words - 6 pages in urbanisation. Taking this finding one step further, we were interested in establishing the most important parameter influenced by urbanisationthat also causes the greatest rate of change in PET. A multi-criteria decision-making (MCDM)and artificial neural network (ANN) approach was used to achieve this aim. After first introducing MCDM and ANNs in more detail in section 2, as well as the specific methodology of the study,the results and discussion are presented in section 3.Finally, theconclusionof the study is given in section 4.

Will Grade Approach Facilitate Decision Making In Insufficient Evidence?

1203 words - 5 pages restriction on recommendations and facilitating decision making process by gathering more information or taking more factors into consideration. Compared with the 4 domains proposed by USPSTF, GRADE Evidence to Recommendation approach showed no differenesin faciliatating the decision making process.