Search

• Subjective real option valuation uses same data inputs as traditional DCF analysis. • The value of delay stems from the investor's subjective views about risk premia. • Cost and revenue uncertainties have complex effects on the option value. • Hedging systematic risk can reduce the value of delaying investment. • The option value may increase or decrease with idiosyncratic, un-hedgeable risk. [Display omitted] We model investor heterogeneity using different required returns on an investment and evaluate the impact on the valuation of an investment. By assuming no disagreement on the cash flows, we emphasize how risk preferences in particular, but also the costs of capital, influence a subjective evaluation of the decision to invest now or retain the option to invest in future. We propose a risk-adjusted valuation model to facilitate investors' subjective decision making, in response to the market valuation of an investment opportunity. The investor's subjective assessment arises from their perceived misvaluation of the investment by the market, so projected cash flows are discounted using two different rates representing the investor's and the market's view. This liberates our model from perfect or imperfect hedging assumptions and instead, we are able to illustrate the hedging effect on the real option value when perceptions of risk premia diverge. During crises periods, delaying an investment becomes more valuable as the idiosyncratic risk of future cash flows increases, but the decision-maker may rush to invest too quickly when the risk level is exceptionally high. Our model verifies features established by classical real-option valuation models and provides many new insights about the importance of modelling divergences in decision-makers risk premia, especially during crisis periods. It also has many practical advantages because it requires no more parameter inputs than basic discounted cash flow approaches, such as the marketed asset disclaimer method, but the outputs are much richer. They allow for complex interactions between cost and revenue uncertainties as well as an easy exploration of the effects of hedgeable and un-hedgeable risks on the real option value. Furthermore, we provide fully-adjustable Python code in which all parameter values can be chosen by the user. [ABSTRACT FROM AUTHOR]

Precise valuation of the economic efficiency of risky investment projects in the mineral sector has a direct impact on the range of future investments. Since the mid-90s, a number of enterprises have also been giving increased attention to the valuation of managerial flexibility that cannot normally be estimated with classical discounted cash flow (DCF) analysis. This has been the result of a development in the real options analysis (ROA) and the simplification of its algorithms, most of which have been achieved through: Unfortunately, in most cases, models constructed on the abovementioned assumptions and modifications are not consistent with real projects. Some analysts recognize that project PVs might not follow the multiplicative process, which could have a direct impact on the project's value. In order to improve the MAD approach, the paper proposes a modified model where the multiplicative tree is replaced with an additive one. In addition, methods of 'additive volatility' calculation and 'dividend' adjustments were suggested. [ABSTRACT FROM AUTHOR]

Abstract: In this paper, we present a fuzzy linguistic ontology payoff method for the valuation of real options in the aerospace industry. Using real data, we apply the fuzzy linguistic approach to determine the credibility measures and the credibilistic expected value for the fuzzy real options valuation payoff method. This approach is used to obtain a multi-scenario modeling process by envisioning three scenarios: optimistic, most likely, and pessimistic. In addition, our experience with the scenario estimates is premised on results in an operating profit forecast. This forecast corresponds to a plausible outcome within the aerospace licensing maintenance, repair, and overhaul market and provides a decision-making tool. This tool can be utilized for determining real options for project valuation of aerospace licensing revenues based on unit costs, recurring costs, and quantity of units sold. [Copyright &y& Elsevier]

Real option is synonymous with financial flexibility. Traditional valuation has always ignored this flexibility and has provided inappropriate estimate of the projects for decisions. This paper tries to capture different types of real options and their valuations. The Black-Scholes model as suggested by many researchers can be applied only to European option, but in this paper studies that have valued American option using Black-Scholes approach with slight modification are also found. The binomial lattice model is an alternative to value American option, but to avoid complexity binomial tree is more preferred. Given the priori probabilities, decision tree approach provides a simplistic method to value real options. [ABSTRACT FROM AUTHOR]

Climate change has in recent years gathered traction on the business, political and social agenda. From the business perspective, research has shown that climate change impacts on company value are uncertain, significant and strategically important. The challenge therefore is for the business community to apply financial valuation models that support the incorporation of the climate change impacts in strategic planning. However, the commonly used discounted cash flow techniques in capital budgeting are seen as failing to address the high levels of uncertainties inherent in climate change impacts. Real options thinking has been touted as having the potential to enhance understanding of these impacts via its direct handling of uncertainty, although not much research has been done to demonstrate this. Using an illustrative case study, this research presents an argument for introducing the real options approach, a new method for valuing options of future strategic action by companies in a setting that exhibits climate change impacts. The objective of this research is to contribute to the literature on strategic tools for addressing climate change and ultimately offer some management insights that can narrow the gap between finance theory and business practice. Copyright © 2009 John Wiley & Sons, Ltd and ERP Environment. [ABSTRACT FROM AUTHOR]

The article offers information on real-option valuation method and discusses how the technique can efficiently value capital asset projects. Real-option valuation technique trusts on the discounted cash flow (DCF) method and does not alter the DCF computations. The DCF techniques offer a very significant result which is the anticipated value of the project. Real-option approach is generally regarded as an extension of financial option theory used in investment options on real assets.

Most discussions of capital budgeting take for granted that discounted cash flow (DCF) and real options valuation (ROV) are very different methods that are meant to be applied in different circumstances. Such discussions also typically assume that DCF is “easy” and ROV is “hard”—or at least dauntingly unfamiliar—and that, mainly for this reason, managers often use DCF and rarely ROV. This paper argues that all three assumptions are wrong or at least seriously misleading. DCF and ROV both assign a present value to risky future cash flows. DCF entails discounting expected future cash flows at the expected return on an asset of comparable risk. ROV uses “risk-neutral” valuation, which means computing expected cash flows based on “risk-neutral” probabilities and discounting these flows at the risk-free rate. Using a series of single-period examples, the author demonstrates that both methods, when done correctly, should provide the same answer. Moreover, in most ROV applications—those where there is no forward price or “replicating portfolio” of traded assets—a “preliminary” DCF valuation is required to perform the risk-neutral valuation. So why use ROV at all? In cases where project risk and the discount rates are expected to change over time, the risk-neutral ROV approach will be easier to implement than DCF (since adjusting cash flow probabilities is more straightforward than adjusting discount rates). The author uses multi-period examples to illustrate further both the simplicity of ROV and the strong assumptions required for a typical DCF valuation. But the simplicity that results from discounting with risk-free rates is not the only benefit of using ROV instead of—or together with—traditional DCF. The use of formal ROV techniques may also encourage managers to think more broadly about the flexibility that is (or can be) built into future business decisions, and thus to choose from a different set of possible investments. To the extent that managers who use ROV have effectively adopted a different business model, there is a real and important difference between the two valuation techniques. Consistent with this possibility, much of the evidence from both surveys and academic studies of managerial behavior and market pricing suggests that managers and investors implicitly take account of real options when making investment decisions. [ABSTRACT FROM AUTHOR]