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Real options
capture the value of managerial flexibility to adapt decisions in response
to unexpected market developments. Companies create shareholder value by
identifying, managing and exercising real options associated with their
investment portfolio. The real options method applies financial options
theory to quantify the value of management flexibility and
leverage uncertainty in a changing world.
The idea of treating
strategic investments as financial options was brought forward by Timothy A. Luehrman in two Harvard Business Review-articles:
"Investment Opportunities as Real Options: Getting Started on the Numbers"
(July-August 1998) and "Strategy as a Portfolio of Real Options"
(September-October 1998). In the last article Luehrman says: "In financial
terms, a business strategy is much more like a series of options than a
series of static cash flows".
As a result, in valuations that involve
significant future flexibility and/or uncertainty is involved and/or
future cash-flows alone are close to break-even, such as long-term
strategic scenario's, flexibility has become a major source of value and
option (real options) value must be taken into consideration then.
Formula used is Black-Scholes
or other similar. Generally, the
following variables determine the value of having (an) option(s) - option
value:
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Time to expiration
(duration)
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Degree of
uncertainty
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Cost of acquiring
the option(s)
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Potential cashflows
lost compared to full upfront commitment
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Risk-free interest
rate
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Expected present
value of future cashflows
By introducing these
factors into business decision-making, the real options method has
enabled corporate decision-makers to leverage uncertainty and limit
downside risk.
Compare:
Scenario Planning |
PEST analysis |
Root Cause Analysis |
CAPM |
Dialectical Inquiry |
Plausibility Theory |
Theory of Constraints
| Operations Research
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