Real options analysis in strategic decision making.

Abstract

The research addresses the management dilemma of a decrease in the number of capital project investments, due to the current methods of capital budgeting (i.e. net present value analysis using discounted cash flows) being ineffective, because it does not effectively deal with uncertainty in the investment, and also does take management's flexibility into account. It has been determined that a strategic options framework can be used to provide a more meaningful assessment of future business opportunities under uncertainty. The options approach complements the conventional net present value criterion in evaluating risky investment. The options approach provides an immediate and important perspective on value creation because the options approach takes into consideration that management have the choice of deferring the investment to a later date when circumstances are more certain, and there is less risk involved, or the choice of completely abandoning the investment.