ABSTRACT
Chapter 7 outlined a useful approach for valuing real options based on conventional investment thinking using cash flows. It was shown that options can be valued by using a single formula, the Carmichael equation,
OV = Φ × Mean of PW upside
in conjunction with a second order moment analysis (or Monte Carlo simulation if desired). Here Φ is P[PW > 0] and the PW upside is the area of the PW distribution to the right of the origin (PW > 0). OV is an estimate of the option value. This applies for both call-style and put-style options. It assumes that anything favourable to the investor be classed as a cash inflow and anything unfavourable as a cash outflow. That is, no distinction is made between buying and selling; rather each investment is interpreted from the viewpoint of the investor, not in any strict accounting sense.
