Valuation of the Liability Structure by Real Options

1The Utility of Real Options in the Valuation of Liabilities

1.1. Introduction

Traditional valuation methods can appear overly static when faced with the need to account for the notion of the overall company risk through the volatility of its assets, as well as the need to determine the economic value of the debt, which until now, has been ignored. Indeed, insofar as the final objective of each of these valuation methods is to obtain the economic value of equity, that of net debt cannot be separated from this consideration if we take it to its logical conclusion.

Moreover, each of these traditional methods can be critiqued. The subjectivity of hypotheses in the construction of a business plan at the heart of the DCF method, the disparities at the heart of a sample set of companies belonging to the same business sector leading to falsified sector-specific multiples, and even the failure to consider any potential growth at the heart of the patrimonial approach are all faults that bias the valuation and raise the question of the pertinence of these traditional methods, suggesting the possibility that a complementary and innovative method exists.

Insofar as the assets of a company can be considered a portfolio of real options, nothing negates the idea that it would be the same for liability. And indeed, the value of company equity and debts can also be studied in the field of options.

This approach allows us to separate the equity of a company into intrinsic value and time value. ...