Real options analysis
What is real options analysis?
This is a way of applying option valuation techniques to investment decisions. A real option is the right to undertake a business initiative, such as setting up a capital investment project.
Where have you heard of real options analysis?
You might have heard of it being called real options valuation. People who use real options analysis include research and development managers, who might use it to help them allocate their budget between different projects.
What you need to know about real options analysis.
The idea of real options is fairly recent, and was first put forward in the 1970s. Real options are different to normal financial options because they’re not something that can be traded as a security. Real options are most important to business managers when there are high levels of uncertainty, because they provide flexibility to change the course of a project if needed. The main things they will be able to alter include the size of a project, its timing, and how it will work once it’s been set up.
Find out more about real options analysis.
To learn more about this process, check out our guide to capital budgeting.