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Name and surname of author:

Year:

2008

Issue:

1

Keywords:

real option, evaluation of investment, managerial decisions, managerial flexibility

JEL clasification:

DOI (& full text):

Article:

Anotation:

An effective management is the only way to a successful fulfilment of company‘s top objectives.
The management can be effective only if has got ‚in a hand‘ appropriate instruments. Current
approaches do not always constitute optimal instruments for evaluation of investment projects or
determination of a company‘s value.
As they stay, these approaches are based on discounted cash flows which give estimated gains
in the case of a realization of a particular project. In addition, they can be extended with i.e. the
sensitivity analysis so that they reflect also random internal or external variations of the company.
However, what the current approaches do not take into account at all are options of the managerial
flexibility - that means to work out and eventually to perform the project‘s expansion, shut down or
hold up with a choice to start it up again in the case of a positive progress.
Such a chance, which is represented by the theory of real options, seems to be very helpful and
effective on the way to a successful fulfilment of company‘s top objectives - for example by the
evaluation of a project or by ensuring a competitive advantage in the market.
The methodology of real options does not compensate for the standard techniques of investment
evaluation, but rather presents a significant (and often necessary) supporting method for
them. This is in particular true in cases when managers have to make decisions about large investments
under high level of uncertainty and volatility - it opens a large field for managerial flexibility
which should be effectively examined. Other examples are those cases in which the net present
value was shown as problematic for such investments, which could have been effective but because
of higher risk and higher discount rates were declined.
In such cases, the standard techniques are in a conflict with the real options methodology which
says that the uncertainty and the time factor increase the value of a project.…

An effective management is the only way to a successful fulfilment of company‘s top objectives.

The management can be effective only if has got ‚in a hand‘ appropriate instruments. Current

approaches do not always constitute optimal instruments for evaluation of investment projects or

determination of a company‘s value.

As they stay, these approaches are based on discounted cash flows which give estimated gains

in the case of a realization of a particular project. In addition, they can be extended with i.e. the

sensitivity analysis so that they reflect also random internal or external variations of the company.

However, what the current approaches do not take into account at all are options of the managerial

flexibility - that means to work out and eventually to perform the project‘s expansion, shut down or

hold up with a choice to start it up again in the case of a positive progress.

Such a chance, which is represented by the theory of real options, seems to be very helpful and

effective on the way to a successful fulfilment of company‘s top objectives - for example by the

evaluation of a project or by ensuring a competitive advantage in the market.

The methodology of real options does not compensate for the standard techniques of investment

evaluation, but rather presents a significant (and often necessary) supporting method for

them. This is in particular true in cases when managers have to make decisions about large investments

under high level of uncertainty and volatility - it opens a large field for managerial flexibility

which should be effectively examined. Other examples are those cases in which the net present

value was shown as problematic for such investments, which could have been effective but because

of higher risk and higher discount rates were declined.

In such cases, the standard techniques are in a conflict with the real options methodology which

says that the uncertainty and the time factor increase the value of a project. However, the uncertainty

and the managerial flexibility are exactly the factors that can make an average company to be

a top one.

This paper presents new findings in the area of the value assessment which can be subsequently

implemented for a better choice of the optimal strategy in the company‘s decision-making

process. An application of the binomial model and an option thinking methodology by managerial

strategy decisions are shown. The paper illustrates and summarises the steps in a real options

analysis and also recapitulates the main group of real options with thein short explanations accompanied

by arithmetic formulas.

The management can be effective only if has got ‚in a hand‘ appropriate instruments. Current

approaches do not always constitute optimal instruments for evaluation of investment projects or

determination of a company‘s value.

As they stay, these approaches are based on discounted cash flows which give estimated gains

in the case of a realization of a particular project. In addition, they can be extended with i.e. the

sensitivity analysis so that they reflect also random internal or external variations of the company.

However, what the current approaches do not take into account at all are options of the managerial

flexibility - that means to work out and eventually to perform the project‘s expansion, shut down or

hold up with a choice to start it up again in the case of a positive progress.

Such a chance, which is represented by the theory of real options, seems to be very helpful and

effective on the way to a successful fulfilment of company‘s top objectives - for example by the

evaluation of a project or by ensuring a competitive advantage in the market.

The methodology of real options does not compensate for the standard techniques of investment

evaluation, but rather presents a significant (and often necessary) supporting method for

them. This is in particular true in cases when managers have to make decisions about large investments

under high level of uncertainty and volatility - it opens a large field for managerial flexibility

which should be effectively examined. Other examples are those cases in which the net present

value was shown as problematic for such investments, which could have been effective but because

of higher risk and higher discount rates were declined.

In such cases, the standard techniques are in a conflict with the real options methodology which

says that the uncertainty and the time factor increase the value of a project. However, the uncertainty

and the managerial flexibility are exactly the factors that can make an average company to be

a top one.

This paper presents new findings in the area of the value assessment which can be subsequently

implemented for a better choice of the optimal strategy in the company‘s decision-making

process. An application of the binomial model and an option thinking methodology by managerial

strategy decisions are shown. The paper illustrates and summarises the steps in a real options

analysis and also recapitulates the main group of real options with thein short explanations accompanied

by arithmetic formulas.

Section:

Finance