Embedded options are also referred to as compound options and involve a series of real options or nested investments (e.g., investments in new technological innovations, geographic markets, etc.) as opposed to making a single lump-sum investment. They can no longer be treated as independent investments but rather as links in a chain of interrelated projects, the earlier of which are prerequisites for the ones to follow. An initial foothold investment confers privileged access to information and opportunities for future investments. Each stage completed gives the firm an option to complete the next stage (e.g., expand or scale up projects) but the firm is not obliged to do so (e.g., abandonment options). The investment problem essentially boils down to discovering a contingency plan for making these sequential (and irreversible) expenditures.
Published in Chapter:
Real Options Reasoning as a Tool for Managerial Decision Making
Bernadette Power (University College Cork, Ireland)
Copyright: © 2008
|Pages: 10
DOI: 10.4018/978-1-59904-843-7.ch086
Abstract
An understanding of human decision making is a fundamental step toward the development of effective intelligent decision support systems (Newell & Simon, 1972; Pomerol, 1997). Many methods have been put forth by decision theory to provide us with an understanding of human decision making and to enable individuals to make better decisions such as in utility maximization (Savage, 1954), satisficing (Simon, 1983), statistical and regression analysis, case-based reasoning (Gilboa and Schmeidler, 1995, 2000), game theory (von Neumann & Morgenstern, 1947), decision trees (Yuan & Shaw, 1995), and so forth. This article focuses on a new approach, namely, real options analysis, as a tool for effective decision making by management when faced with uncertainty in its environment.