Chapter 35 Real Options

Up to now we have been almost entirely concerned with the valuation of financial assets. In this chapter we explore how the ideas we have developed can be extended to assess capital investment opportunities in real assets such as land, buildings, plant, and equipment. Often there are options embedded in these investment opportunities (the option to expand the investment, the option to abandon the investment, the option to defer the investment, and so on.) These options are very difficult to value using traditional capital investment appraisal techniques. The approach known as real options attempts to deal with this problem using option pricing theory.

The chapter starts by explaining the traditional approach to evaluating ...

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