15 The Fundamental Uncertainty of Business: Real Options
The purpose of this paper is to discuss the manner in which uncertainty is currently evaluated in business, with an emphasis on economic measures. In recent years, the accepted approach for the valuation of capital investment decisions has become one based on the theory of real options. From the standpoint of this workshop, the interesting aspect of real options is its focus on the flexibility of management to respond to changes in the environment as a feature of an alternative that has unique value, known as “option value.” While this may not be surprising to most participants in this workshop, it does represent a radical change in traditional thinking about risk in business, where efforts have primarily been focused on the elimination of risk when possible.
Prior to my presentation, Henri Lipmanowicz posed a question and requested a response, so we begin this discussion with that exchange. Next, real options are introduced and discussed at an elementary level, but with an emphasis on th e value of managerial flexibility as a response to uncertainty and the possibility of a surprise.
KeywordsCash Flow Real Option Capital Asset Price Model Discount Cash Flow Discount Cash Flow
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