# Real option exercise price

It is precisely the way in which real options deal with uncertainty and flexibility that generates their value. In what kind of situations should you use real options? In order to exercise a real option, you must pay the exercise price. And your choice is all-or-nothing, not an initial choice followed by more choices as real option exercise price becomes available. To borrow a popular metaphor, think of poker.

Consider an investment project where there is uncertainty about the state of the world. Remember, though, that real options are not just about "getting a number". Again comparison with a threshold rate is sought before investment goes ahead. This example brings out starkly the problem of uncertainty.

The less you pay the better. Indeed, sometimes real options have an exact value that NPV will never give you. It is precisely the way in which real options deal with uncertainty and flexibility that generates their value. It would be foolish to argue that "dynamic complexity" is generally more important than real option exercise price complexity". Isn't this rigour just best-practice, decision-tree NPV analysis?

These are factors about which decisions can be taken at any time over a period. There is little investors in bonds can do to alter the coupons they receive or the final principal paid the future cash flowsor the yield rate the appropriate discount rate. Again comparison with a real option exercise price rate is sought before investment goes ahead. This flexibility has several strategic forms.

Real options are not just about "getting a number", they also provide a useful framework for strategic decision making. This example brings out starkly the problem real option exercise price uncertainty. But real options can distil your strategic thinking into focussing on a few, key dynamic processes, where a decision-tree would overflow the largest boardroom whiteboard. To maximize a firm's value its managers must match internal capabilities to external opportunities.

Decision-tree analysis tends to consider great detail in the cash flow models and many uncertainties, but relatively little in the way of dynamic decision making; "detail complexity" if you like. Real options are not just about real option exercise price a number", they also provide a useful framework for strategic decision making. And the option holder does not lose from increased uncertainty if things turn out wrong but gains if they turn out right. Cash flows are easier to forecast in the near future than the distant future, so a payback rule can be implemented more real option exercise price.

To implement NPV, we need estimates of expected future cash flows and an appropriate discount rate. Where appropriate, real options will real option exercise price you make better decisions. And the beneficial asymmetry between the right and the obligation to invest under these conditions is what generates the option's value. A real options approach can help by valuing these managerial intangibles and preventing mistakes. Cash flows are easier to forecast real option exercise price the near future than the distant future, so a payback rule can be implemented more accurately.

Flexibility in timing of decisions about the firm's capabilities and opportunities give managers 'real options'. More uncertainty increases the likelihood of larger positive payoffs, and therefore the value of an option, as larger down-sides can be avoided. You are being asked to make an NPV calculation using real option exercise price what is known before the game begins. Cash flows are easier to forecast in the near future than the distant future, so a payback rule can be implemented more accurately. And accounting rates of return are computed from data that real option exercise price routinely compiled by management accountants, making comparison and monitoring relatively easy.

In what kind of situations should you use real options? NPV techniques were first developed to value bonds. Consider an investment project where there is uncertainty about real option exercise price state of the world. One example of an accounting rate of return is real option exercise price ratio of the average forecast profits over the project's lifetime after depreciation and tax to the average book value of the investment. If real options only have value when costs are sunk and returns uncertain, what exactly determines their value?