Real Option and Practical Application

Document Type:Essay

Subject Area:Finance

Document 1

It is a choice made available to managers of a form concerning investment opportunities. It is termed “Real” because it references projects that mainly involve tangible assets rather than financial instruments (Amran& Howe, 2003). Real choices and options in a firm`s management aim to expand, alter or curtail plans basing on market conditions and economic, technological advancements. The real options mainly affect the valuation such as net present value. Using real options analysis, the firm can approximate opportunity costs or abandon the whole project. The main contribution is the unfolding of real options perspectives that many business strategic management is improving compared to its predecessors in the acknowledgment of the option as a way to improve their operations. Summary of Triantis Journal According to Triantis` Journal (2005), the implementations are varying but appear in a common path to successfully adopt real options.

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The fundamentals steps include having buy-in from the rank and file managers or from the senior level, conduction of pilot projects, integration and institutionalization of real options across all departments in the company, codifying real options techniques and ideas in specialized training, expert working groups or throughout the customization. The operations may comprise activities such as dividing many big projects into multiple stages, production of information, acquisition of finance, introducing modularity in design and production, creating a highly competitive, prototypes from the firm during the introduction of fresh products or services and also overseeing finance in international markets. However, if real techniques and ideas have succeeded as the simple way of thinking and applications of real options; it has been restricted to organizations in relatively few industries, and thus it has not lived up to expectations developed in the mid to late 1990s.

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Real options are not part of the decision on trading assets as the commercial options. Another thing about real options is that managements freely influence the worth of the underdoing projects whereas this more often not brought into accounts regarding the security of the financial choice. Additionally, management cannot operate in volatile and uncertain matters as in real option argument. In contrast to financial options, managers go ahead to discover real options such as entrepreneurial and business obligations. The real option is a highly valuable tool in the scenarios of high uncertainty matters especially when the firm is flexible enough to change the course of options. The financial options need managers always to behave optimally to make real options behave better than before.

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The real extension in the real word needs super custom decisional support systems because they are complex and may become extremely hard to handle. In simple terms, while real options are the expenditure required to acquire the upfront investment while in practice it is the stock price. Real options are the present value of the project or asset while in practical or financial options it is the strike price. Real options involve period prior the opportunity expires while in the functional term it is the time to maturity. To curb these differences, the company need to value investments project by simplifying assumptions that are more heroic and calculations based on options. The second difference between financial options and real options is the clarity of terms in options.

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The right to exercise mandate in financial choices is unambiguous. For instance, the holder of the particular financial choice on IBM want to buy 50 shares at a fixed price of $40 at any time of the season before the specified maturity date. It is not clear what the option holder of the real choices has the right to purchase or how long will maturity date takes. It is no doubt that all uncertainties cannot be quantified and identified. However, real options approaches can assist firms to define boundaries without undermining the quality of decision-making process. Real options help the firm to identify bad results and support them to concentrate on the resources that show promising opportunities. Additionally, real options help reduce the uncertainty by lowering cost while maximizing the value of the company’s products and services.

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