Real Options for the Valuation of Investment Projects: Practical Case

Abstract

The objective of this chapter is to analyze the methodology for evaluating investment projects through real options. The limitations of traditional models based on cash flows and the current environment that presents constant changes and high uncertainty have led to a new field of research, real options. The valuation of investment projects carries inherent decision-making, where the best options for the company are analyzed, the real options providing a decision flexibility that classic models do not provide. This chapter contains the most important theoretical framework, where the beginnings of this methodology, the most important types of options, and the methodology for their evaluation are discussed, as well as two practical examples for a better understanding of this methodology.

Key Terms in this Chapter

Investment Project: Possibility of the companies for carry out different investment and possibilities of decision making.

Binomial Model: Valuation model based on the binomial distribution where a value can take two different scenarios, one rising and the other falling.

Real Option: Extrapolation of the definition the financial option to non-financial assets.

Financial Option: It is a contract where one of the parties has the right but not the obligation to buy (call option) or sell (put option) an asset at a strike at a certain period of the time to the other party.

Uncertainty: Lack of knowledge of the future behavior of an event due to the lack of information on the variables that will affect that event.