Chapter 10
Multistage Real Options
10.1 Introduction
Chapter 7 introduced the notion that investments in human systems integration (HSI) can be evaluated as real options. In short, real options analysis is based on the recognition that many real-world business investment opportunities resemble financial options. Consequently, they can be evaluated using the powerful tools developed to value financial options.
This chapter explores the real options approach to valuing investments, in particular, the multistage investments typical of technology development efforts. To motivate the exposition, a notional example of an HSI investment opportunity is presented. The example highlights the fundamental investment valuation issues that real options analysis attempts to address. This leads to a discussion of the fundamentals of investment analysis and to a discussion of the evolution of real options analysis.
With a basic understanding of the principles of options analysis, the chapter then covers how to value a real option. First, a conceptual approach to valuing an option is presented. This is followed by a discussion of the pros and cons of the most common methods for solving real options with particular emphasis on lattice methods. Next, the example problem is solved using the binomial lattice method. Finally, the chapter concludes with a brief discussion of the practical issues involved in the application of real options analysis.
10.2 A Motivating Example
To understand ...
