Real Options

• Any time a firm has the ability to make choices, there is a

value added to the project in question

• traditional NPV analysis ignores this value

• the study of real options attempts to put a dollar value on the

ability to make choices
What is a real option?
• Real options exist when managers can influence the size and risk of a
project’s cash flows by taking different actions during the project’s life
in response to changing market conditions.

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How are real options different from financial
options?
• Financial options have an underlying asset that is traded--usually a
security like a stock.
• A real option has an underlying asset that is not a security--for
example a project or a growth opportunity, and it isn’t traded.

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Capital Projects and Real Options
Types of real options
• Investment timing options—delay the decision.
• Growth options
• Increase the capacity of an existing product line
• Add new products
• Expand into new geographic markets
• Abandonment options
• Contraction
• Temporary suspension
• Flexibility options
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The six levers of financial and real options
Why real options are important
Choosing your levers