The owners of real options have the right, but not the obligation, to expand or contract their investment in a real asset (i.e., physical things rather than financial contracts) at some future date when uncertainties exist regarding the future value of the real asset has been resolved. Strategic investment and budget decisions within any organisation are decisions to acquire, exercise (e.g., expand, contract, or switch), abandon (e.g., temporarily or permanently), or let expire real options. The ability to delay the decision to invest introduces flexibility into this financial instrument.
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.