Disadvantages Of Real Options Analysis

Introduction

Real options analysis is a method used to value flexible strategies in this tentative world. It is usually built on the Traditional Discounted cash Flow method but it overcomes the disadvantages of Traditional DCF technique. Real options is a mix of quantitative techniques given by Black and Scholes along with binomial approach given by Cox et al(1979). Uncertainty, and the difficulty to value the flexibility are limitations of the Traditional DCF approach to value a project and thus this article researches on a flexible strategy that adapts to conditions as uncertainty is resolved.

A real option gives the holder the right not the obligation to buy or sell a particular quantity of an underlying asset at a particular price also

According to Marketable Asset Disclaimer we need to use assumptions of Traditional analysis.

• Firstly, a model is built to imitate specific fixed services which are assumed to be the underlying assets. It then provides their present values and these are utilized as market prices. The model also states the volatilities and correlations related to the project.

• The second step defines the price process being modelled into a network to assess the option. Here one option is used to exchange risky incomes with other. The various income streams become the alternative services that are necessary to be evaluated to formulate a flexible

The value of option is calculated as $13.43million wherein flexible strategy exhibits an NPV of $10.58 million when compared to original strategy showing on $4.27 million. In short, strategy 1 is useful and as uncertainty rises, they can order for the second ship and expand operation or continue operations only at Klang. This is dependent on the calculations of 6month decision period.

Conclusion:

Real Options Analysis is very useful technique in valuing the flexibility which organizations have to adapt when uncertainty arises along with information and time in hand. A flexible strategy along with option of expanding services is estimated as an option to exchange oen risky stream of income with another two. In this analysis decisions can be changed during course of project looking at the positives and negatives. The process of folding back every six months is required to assess the viability of the option.

LEARNINGS:

 While managing a project various decisions need to be made in relation to the investment. All projects come with risks attached to them, some being certain and some being uncertain. Each project’s risk must be mitigated depending upon the risk appetite of the individual or the firm. The one having higher NPV is selected over