Previous

Page - 2

Real Options Concept

"Real option" perspective contrasts with the traditional view of a project as set of decisions made once at the beginning and unchanged during the life of the project. However, projects decision keeps changing during its lifetime, and here real options becomes valuable.

The real option approach recognizes that the risk can be managed and use of real options practically always leads to higher values for the same project than the traditional methods (because future decisions are made as uncertainties resolved). Avoidance of losses and exploitation of gains is incorporated in the analysis leading to a higher perception of value of risky projects.

A "real option" deals with investments with options-like characteristics that are not traded as securities in financial markets. The capability to bring a new product to market (based on having invested in the necessary research and development) is a "real option". This capability enables a company to produce the new product, if the market is favorable, but does not obligate the company to do so, if the market is unattractive.

"Real options" exist wherever and whenever investments involve strategic choices over time that managers can actively direct. For example: -