Capital Projects and Real Options

Real options represent a company’s rights to make chronological decisions in a capital project.

Real options increase the NPV of a project because a firm would not rationally exercise an option which lowers value.

Types of Real Options

Evaluating Real Options

Calculate the project’s NPV without any options.  If the project has a positive NPV, then real options will increase its value.

If the project without any options has a negative NPV, then make adjustments based on the value of associated real options.  The analyst must determine if the value of the real options is sufficient to create a positive NPV.

Incorporate the use of decision trees or option pricing models to evaluate a capital project.