Laura Martin: Real Option
...change is more rapid than ever. Emerging business models
are challenging traditional ways of doing business. Newly unregulated markets
are contributing to greater uncertainty. If-it-ain’t-broke-don’t-fix-it is giving
way to break-it-before-someone-else-does.
The breakneck pace of change and elevated uncertainty demand new ways of
strategic thinking and new tools for financial analysis. Real options are at the
core of such a strategic and financial framework.
We believe that real options will become an increasingly important tool in security
analysis. Real options provide the analytical flexibility that standard valuation
frameworks lack. The major points of our analysis are as follows:
· Real options defined. The real options approach applies financial option
theory—the best-known form is the Black-Scholes model—to real investments,
such as manufacturing plants, line extensions, and R&D investments.
This approach provides important insights about businesses and strategic investments,
insights that are more important than ever given the rapid pace
of economic change.
· The marriage of strategic intuition and analytical rigor. The real options approach
is best viewed as a complement to standard DCF analysis. For those
comfortable with DCF, real options have substantial intuitive appeal. By
adding an important dimension of analytical flexibility, real options allow for a
better melding of strategic intuition and analytical rigor.
· Evolution of strategy and finance. Most traditional businesses can be valued
using DCF, as the general focus is optimization—doing things better today
than yesterday. Emerging businesses are best valued using real options, as
the focus is on “the next big thing.” As the strategic landscape evolves, so
too must the tools to evaluate it.
· Where real options apply. The real options approach is particularly relevant...
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