THE APPLICATION OF REAL OPTION THEORY IN ENTERPRISE RISK INVESTMENT EVALUATION
Abstract
Real option has a great implication in real world where the feasibility of the project is analysed not only by considering the downside risk but the opportunity of benefits due to upward variability is also taken into account. In this paper, the Real Option is discussed in detail where the mathematical models like Binomial Model, Black Scholes Model and Simulation methods for the financial option are used to value the Real Option. It is also discussed how the capital budgeting tools like NPV give a static picture of the financial feasibility of a project but, if an option is added to the analysis; the earlier rejected project may turn to be accepted. The Real Options of delay, expansion and abandonment of projects are discussed in detail with examples. Further, the difficulties of deciding the inputs and their values are also discussed with limitations in implementation to the real situation.
Keyword : Real option, binomial, put option, cash flow, NPV
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