FAQ Number 8

Does Real Options Theory (ROT) Speed Up the Firms Investments or Slow Down Investment?

Answer: depends of the kind of investment

• ROT speeds up today strategic investments that create options to invest in the future.
  Examples: investment in capabilities, training, R&D, exploration, new markets...
• ROT slows down large irreversible investment of projects with positive NPV but not “deep in the money”.
  Example: the development of an oilfield by investing one billion dollars, with a NPV of only US$ 20 millions. With a small change in the markets parameters, the project could become a losing money project. In this case, if is not a "now-or-never" opportunity, the better is to wait and see for better conditions. In this example the oilfield is not "deep-in-the-money", it is only "in-the-money".
• However, large projects with high profitability (“deep in the money”) must be done by both approaches, ROT and static NPV.

In general, if your investment process creates new options or learning effects, the real options speeds up investment when compared with static discounted cash flow.
Investments in R&D, in training, new distribution channels, etc., create new options that can be exercise in the future depending of the market evolution.

The next FAQ will show that real options can even to recommend project with negative static NPV.