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The Promise Of Real Options

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  • Aswath Damodaran

Abstract

In recent years, both practitioners and academics have argued that traditional discounted cash flow models do a poor job of capturing the value of the options embedded in many corporate actions. This paper shows how option pricing models used in valuing financial assets can be used to value three kinds of real options that are often built into corporate projects: the option to delay, the option to expand, and the option to abandon. As a number of examples in this paper suggest, corporate investments that would be rejected using conventional DCF analysis can sometimes be justified by the value of the strategic options they provide. As the illustrations also show, however, the pricing of real options is considerably more difficult than the pricing of financial options and adjustments must often be made to capture the complexity of real investments.

Suggested Citation

  • Aswath Damodaran, 2000. "The Promise Of Real Options," Journal of Applied Corporate Finance, Morgan Stanley, vol. 13(2), pages 29-44, June.
    • Handle: RePEc:bla:jacrfn:v:13:y:2000:i:2:p:29-44
    DOI: 10.1111/j.1745-6622.2000.tb00052.x
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    Cited by:

    1. Miranda Reed-Grice & Brandon E. Ross, 2024. "Application of the Black–Scholes Financial Model to Support Adaptability as a Sustainability Strategy for Buildings: A Case Study of an Adaptable Campus Parking Garage," Sustainability, MDPI, vol. 16(7), pages 1-19, March.
    2. Sinha, Pankaj & Mudgal, Hemant, 2011. "Valuation of 3G spectrum license in India: A real option approach," MPRA Paper 31281, University Library of Munich, Germany.
    3. Marcello Basili & Fulvio Fontini, 2005. "Quasi-option value under ambiguity," Economics Bulletin, AccessEcon, vol. 4(3), pages 1-10.
    4. Darby, Paul M. & Mark, Tyler B. & Detre, Joshua D. & Salassi, Michael E., 2011. "Advanced Biofuel Production in Louisiana Sugar Mills: an Application of Real Options Analysis," 2011 Annual Meeting, July 24-26, 2011, Pittsburgh, Pennsylvania 103747, Agricultural and Applied Economics Association.
    5. Carol Alexander & Xi Chen, 2014. "Risk-adjusted Valuation of the Real Option to Invest," ICMA Centre Discussion Papers in Finance icma-dp2014-19, Henley Business School, University of Reading.
    6. repec:ebl:ecbull:v:4:y:2005:i:3:p:1-10 is not listed on IDEAS
    7. Sinha, Pankaj & Sathiyanarayanan, Nataraj, 2012. "Valuation of 2G spectrum in India- A real option approach," MPRA Paper 40470, University Library of Munich, Germany.
    8. Gantenbein,, 2016. "Unternehmerisches Finanzmanagement – Meilensteine der Entwicklung," Die Unternehmung - Swiss Journal of Business Research and Practice, Nomos Verlagsgesellschaft mbH & Co. KG, vol. 70(4), pages 387-406.
    9. Akalu, M.M. & Turner, J.R., 2002. "Investment Appraisal Process in the Banking & Finance Industry," ERIM Report Series Research in Management ERS-2002-17-ORG, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
    10. Fernández, Pablo, 2002. "Valuing real options: frequently made errors," IESE Research Papers D/455, IESE Business School.

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