ABSTRACT
A similar gap between the decision analysis and fi nance disciplines exists in the academic literature and professional practice. This gap has become increasingly apparent with the development of option pricing tech niques for valuing projects in which managerial flexi bility or "real options" play an important role. As an example of a real option, suppose a firm is considering
obtaining rights to a new chemical process. With these rights they could invest now and build a plant using the new process. Alternatively, they might obtain a oneyear option on these rights and wait a year before de ciding whether to build the plant. If conditions prove favorable in one year, they can build the plant; if con ditions prove unfavorable, they can decline and avoid losses they would have incurred had they built the plant now. These kinds of options may have substantial value and, it is argued, are often ignored or undervalued in discounted cash flow analyses. (See, for example, Robichek and Van Home 1968.)
In response to these criticisms, finance theorists have proposed the use of option pricing1 techniques-like those used to value puts and calls on stocks-for valuing risky projects in which real options play an important role (see Myers 1984; see Pindyck 1991 for a recent review). Decision scientists, on the other hand, have suggested that these options car be readily incorporated
into decision tree or dynamic programming models (see Bonini 1977). Now we find the advocates of option pricing methods claiming superiority over derision analysis methods: ". . . we have shown the optionpricing approach is superior to both the NPV technique and DTA [derision tree analysis] when naively applied" (Copeland et al. 1990, p. 353; see also Mason and Mer ton 1985 and Trigeorgis and Mason 1987).
