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,
- 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
The next FAQ will show that real options can even to recommend project
with negative static NPV.
Go to the Next FAQ: 9) Is possible real
options to recommend investment on a negative NPV project?
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