Real options valuation

Business valuation by the method of real options. Real options valuation - Wikipedia

According to many, Real-Options have the possibility to improve all sorts of capital budgeting decisions, aligning financial analyses with strategic analyses, by taking future exibility into account.

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Unfortunately, the current debate is not focused on how Real-Options could improve the overall company valuation, but tends to focus on the shortcomings of either a DCF analysis or a Real-Options approach.

However, both approaches could be complementary.

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This research's objective is to determine when and how Real-Options theory could be applied to improve the valuation of companies and how this information can be used to modify the enterprise DCF model. Thereby, we deliver both a theory and a model for incorporating the value of Real-Options into business valuation by the method of real options valuation of a company.

Basically, the Real-Options literature is divided into two camps, proponents and opponents.

  • Real Option Definition
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  • Real options valuation - Wikipedia
  • Types of real options[ edit ] Simple Examples Investment This simple example shows the relevance of the real option to delay investment and wait for further information, and is adapted from "Investment Example".
  • The real power of real options

By performing an extensive literature search, which started with critically reviewing the fundamentals of Real-Options theory, we attempted to identify the true potential of Real-Options theory. In order to translate this potential to functions that could improve a DCF valuation of a company, we analysed the enterprise DCF model as well.

How to value a company

These two analyses led to several functions of Real-Options theory that were worth studying. After an evaluation, we chose to operationalise the bottom-up valuation of short-term strategic Real-Options.


A real case, acquired from PhiDelphi, was used to demonstrate our concept and to find out and show to what level of detail we are able to operationalise our generalised model.

We found that Real-Options are more than rights on a company's traded assets and that Real-Options theory represent an important tool to value flexibility, not only to value flexibility in operational activities, but also to value strategic opportunities.

A real option is an economically valuable right to make or else abandon some choice that is available to the managers of a company, often concerning business projects or investment opportunities. Real options differ thus from financial options contracts since they involve real i. Key Takeaways A real option gives a firm's management the right, but not the obligation to undertake certain business opportunities or investments. Real option refer to projects involving tangible assets versus financial instruments. Real options can include the decision to expand, defer or wait, or abandon a project entirely.

There are several methods to incorporate Real-Options value, e. Broad recognition of decision analysis can be an important step forward for Real-Options theory.

Real Options in Business Valuation Monday, November 14, Business valuation is a complex area that underpins a critical part of modern finance. Equity markets, venture capital markets, and debt markets all rely on accurate valuation metrics to help with efficient allocation of capital.

The developed company valuation model shows how the valuation of strategic Real-Options and a DCF valuation of a company's operational activities could be integrated.

This study also operationalised a valuation guide to value Real-Options and a specific method to model asset value or other variables through time, driven by both market and private risks.

This study aims to contribute to the academic world in a number of ways. First, it contributes to a better understanding of Real-Options.

Integrating Options and Discounted Cash Flow

Our extensive elaboration distinguishes flexibility and strategic Real-Options, Real-Options on project-level and management-level and short-term and distant strategic Real-Options.

Second, it addresses and elaborates on several important valuation methods. By combining theory and methods, we obtained many new insights.

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Future studies could build upon this view. The analysis of the possible functions of Real-Options to improve the valuation of companies also provided insight on the functions that are not suited to improve such a valuation, which is also an important result of this study.

Thinking in terms of real options

Taking into account the results of this study, we recommend practitioners to make a clear distinction between a company's value based on its future operations and a company's value that includes future strategic opportunities. To calculate the latter, one needs to identify a company's strategic Real-Options, for which should be determined how they are influenced by market and private risks and how they are correlated.

CFOs tell us that real options overestimate the value of uncertain projects, encouraging companies to overinvest in them. These concerns are legitimate, but we believe that abandoning real options as a valuation model is just as bad. How can managers escape this dilemma?

When market and private risks can not be separated from each other business valuation by the method of real options they behave in a normalised way, we recommend the MADD approach, which we operationalised.

Further research is needed to the structuring and determination of key variables of several types of strategic Real-Options in order to hand out a practitioner's guide to incorporate strategic Real-Options value. Item Type:.