Real Options and Corporate Strategy
Spring 2005, Volume 17.2
A Response to "Real Options: Meeting the Georgetown Challenge"
A response to Thomas Copeland and Vladimir Antikarov's article: "Real Options: Meeting the Georgetown Challenge"
Managing Operational Flexibility in Investment Decisions: The Case of Intel
Interrelated investments are increasingly common in a “connected” economy where products and technologies are designed across firms and industries. A field study at Intel shows how real options analysis—which is often used to value operating flexibility—can be even more useful in managing flexibility, especially when a decision to defer or expand an investment program has cross-company effects.
Realizing the Potential of Real Options: Does Theory Meet Practice?
Today’s strategic planners are well aware of real options concepts and are designing flexibility into manufacturing processes, product market expansions, and investment projects (including biosciences R&D). But the wider application of real options valuation methods will require more realistic models, simpler techniques, better guidance on implementation, and user-friendly software.
Real Options: Meeting the Georgetown Challenge
Because the assumptions supporting real options (RO) techniques are the same as those justifying traditional DCF analysis, RO can be applied whenever DCF is appropriate. The underlying asset is simply the DCF value without flexibility, and Monte Carlo simulation can be used to estimate the project’s volatility. Real options methods are thus suitable for a wide variety of “non-traded” assets.
Real Options Analysis: Where Are the Emperor's Clothes?
This article discusses the assumptions, mechanics, and range of application of five well-established real options valuation methods: the classic, revised classic, subjective, MAD, and integrated approaches. The revised classic approach is best suited to cases dominated by market or private risk alone, and the integrated approach works best when there is a mix of market and technological risks.
Taking Real Options Beyond the Black Box
For most corporate managers, real options analysis is a “black box” when applied to actual investment decisions. This article shows how a traditional DCF approach can undervalue a project with operating flexibility, and demonstrates that a real options valuation method with a few clear value drivers can build upon and be made consistent with a traditional DCF framework.
The Challenge of Valuing Patents and Early-Stage Technologies
Standard valuation models do not capture the risks in commercializing inventions and generate results that seem irrelevant to managers and investors. Real options thinking can play a major role both in framing the valuation and in guiding managers responsible for the development of early-stage technologies such as patents and licenses, even when quantitative real options models are of limited use.
The Decline and Fall of Joint Ventures: How JVs Became Unpopular and Why That Could Change
From a peak of 5,700 new ventures in 1995, JVs declined sharply to just over 700 new deals in 2004. Many executives now dismiss JVs as a vehicle for growth. The author has five suggestions: avoid over-aggressive negotiating, don’t let the JV contract dominate the relationship, carefully weigh commitment versus flexibility, emphasize the process rather than the outcome, and know when to terminate.
The Option Value of Acquiring Information in an Oilfield Production Enhancement Project
The ability to acquire additional information before undertaking an oil well workover can be quite valuable. In this case study, the two main sources of uncertainty—oil prices and reservoir capacity—are incorporated into a real options valuation framework to determine whether the cost of acquiring up-to-date information on the reservoir is justified prior to the workover.
Value-Based Management in Biosciences Research and Development
In place of traditional methods such as DCF and decision tree analysis that are largely irrelevant for strategic decision-making, decision options analysis—a real-options-based methodology—holds out the promise of better investment and portfolio decisions with fewer data requirements. Case studies outline the application of this technique to biosciences R&D and licensing transactions.
Valuing Assets Using Real Options: An Application to Deregulated Electricity Markets
Relatively simple changes to a standard options valuation model make it possible to analyze a contract for use of a power generation facility and obtain values that are very close to those reported for actual transactions involving similar types of assets. The greater precision and realism of this approach could allow it to be extended beyond the energy industry to minerals and other commodities.
Valuing Pharma R&D: The Catch-22 of DCF
Traditional DCF analysis fails to correctly value pharma R&D projects due in part to the widespread use of established success rates, which lump together projects that do not pass their safety and efficacy trials and those abandoned for lack of economic viability. Real options techniques implicitly account for economic abandonment and are therefore better suited to evaluating new drug development.
The views and opinions expressed in the Journal do not necessarily represent those of Morgan Stanley or its affiliates.
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For close to 20 years, the Journal of Applied Corporate Finance has distinguished itself as a unique forum for addressing the topics that drive corporate value. Featuring articles by top academic thinkers and financial practitioners, this quarterly publication presents the practical application of the best current research in finance.
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