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Real Options Valuation: A Case Study of an E‐commerce Company

Author

Listed:
  • Rocío Sáenz‐Diez
  • Ricardo Gimeno
  • Carlos De Abajo

Abstract

This paper presents a real options valuation model with original solutions to some issues that arise frequently when trying to apply these models to real‐life situations. The authors build on existing models by introducing an innovative and intuitive risk neutral adjustment that allows us to work with all the simulated paths. The problem of incorporating real options into each path is solved with a “nearest neighbors” technique, and uncertainty is simulated using a beta distribution that adapts better to company‐specific information. The model is then applied to a real life e‐commerce company to produce the following insights: the expanded present value is higher than the traditional present value; the presence of several real options make them interact so that their values are nonadditive; and part of the expanded present value is explained by the presence of “Jensen's inequality” that stems from the “convexity” between the value of each year's cash flow and the uncertain variables.

Suggested Citation

  • Rocío Sáenz‐Diez & Ricardo Gimeno & Carlos De Abajo, 2008. "Real Options Valuation: A Case Study of an E‐commerce Company," Journal of Applied Corporate Finance, Morgan Stanley, vol. 20(2), pages 129-143, March.
    • Handle: RePEc:bla:jacrfn:v:20:y:2008:i:2:p:129-143
    DOI: 10.1111/j.1745-6622.2008.00187.x
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    References listed on IDEAS

    as
    1. Trigeorgis, Lenos, 1993. "The Nature of Option Interactions and the Valuation of Investments with Multiple Real Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 28(1), pages 1-20, March.
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    4. Thomas E. Copeland & Vladimir Antikarov, 2005. "Real Options: Meeting the Georgetown Challange," Journal of Applied Corporate Finance, Morgan Stanley, vol. 17(2), pages 32-51, March.
    5. Schwartz, Eduardo S & Moon, Mark, 2001. "Rational Pricing of Internet Companies Revisited," The Financial Review, Eastern Finance Association, vol. 36(4), pages 7-25, November.
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    7. Alex Triantis & Adam Borison, 2001. "Real Options: State Of The Practice," Journal of Applied Corporate Finance, Morgan Stanley, vol. 14(2), pages 8-24, June.
    8. Alexander J. Triantis, 2000. "Real Options And Corporate Risk Management," Journal of Applied Corporate Finance, Morgan Stanley, vol. 13(2), pages 64-73, June.
    9. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," University of California at Los Angeles, Anderson Graduate School of Management qt43n1k4jb, Anderson Graduate School of Management, UCLA.
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