Chapter 9

Real Option Analysis in Valuation of a Company

The discounted cash flow (DCF) approach to target company valuation is based on the implicit assumption that after the investment decision, the decision maker has no options for change. This assumption is unrealistic in that after the investment decision, the management of the acquiring enterprise may have options that could affect the results after the investment. The flexibility in managerial decision making emerges after the acquisition because investment in a new project brings additional new investment opportunities. Accordingly, any investment decision in real assets such as plants, equipment, land, and technology provides real options, that is, the right, not obli­gation, to choose ...

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