Risk and Real Options in Project Appraisal
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Risk and Real Options in Project Appraisal book
The real-options technique deals with the analysis of a project with multiple decision-points and with assigning an economic value to these tangible decision-making opportunities. The analysis of the real options embedded in a given project commences with the discounted cash-flows generated in the traditional way. The real options framework provides the analyst with the platform to incorporate such later day enhancements into today's decision making. In addition to reducing the risk in multi-stage projects, the decision tree analysis could potentially add value to projects by tying expenditures closely to the maturation of a given opportunity. Real options discussed in the chapter help decision makers reduce risk and thus limit the downside by postponing or abandoning a given project investment. However, real options are different in treatment and valuation from financial options, as the exercise price of real options itself could vary with time.