The theory of real options was
made popular by Michael J
Mauboussin, the Chief US Investment Strategist for Credit
Suisse First, Boston and an Adjunct Professor of Finance at the Columbia School
of Business. The use of real options in real business provides a better
flexibility in making business decisions. An
alternative term for real options is strategic options. Real options
have strategic value only if there is management flexibility and an
uncertainty about the outcome.
For a real option, the underlying asset is the value of your
business. The options theory applies to the tangible side of business transaction
and also the real options can be applied to the strategic/intangible or the
virtual aspect of business. Since real options are on real assets, on business
decisions, non-tradability of real options is fairly a large concern. For
example, an option to expand the plant or abandon it are issues specific to
the business and unlike financial derivatives, cannot be traded in
financial exchanges.
The importance of real options comes from the flexibility that it offers
in formulation of business strategy or financial analysis. In the
traditional valuation technique of the discounted cash flow method, Net Present
Value (NPV) of a project can give only a stationary or static view of the net
cash flow or the investment opportunity. The NPV method does not
attach value for `what-if' situations, like `what-if' we start the project one
year later, what if we wanted to abandon the project at a premature stage,
etc. |
