Caveats for Real Options

The discussion of the potential applications of real options should provide a window into why they are so alluring to practitioners and businesses. In essence, we are ignoring the time-honored rules of capital budgeting, which include rejecting investments that have negative net present value, when real options are present. Not only does the real options approach encourage you to make investments that do not meet conventional financial criteria, it also makes it more likely that you will do so the less you know about the investment. Ignorance, rather than being a weakness, becomes a virtue, because it increases the uncertainty in the estimated value and the resulting option value. To prevent the real options process ...

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