Where Real Options Might Really Work
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Authors
Lewis, Neal
Eschenbach, Ted
Hartman, Joseph
Issue Date
2007
Type
Article
Language
en_US
Keywords
Engineering management , Real options , Engineering , Business
Alternative Title
Abstract
Proposed projects are often justified financially by using traditional discounted cash flow tools such as net present value and internal rate of return. These methods have been criticized because they do not recognize the fact that management has the option of making changes in the project if the financial situation changes. Real options analysis is a tool that has been used to assign a value to managerial flexibility. Theory states that the true value of a project can be represented by the sum of the net present value plus the option value, yielding an expanded net present value (ENPV). One area where real options analysis has been used with some success is in the area of natural resources, where the well defined volatility of commodities prices can be used to better predict the volatility of future events. This paper explores an example where real options should provide helpful information through the use of a simplified oil exploration case study that would be suitable for use in the engineering classroom. The case study represents a method to introduce the subject of real options using a realistic application.
Description
© ASEE 2007
Citation
Publisher
ASEE