A framework for applying real options analysis to information technology investments

Abstract

The selection and valuation of information technology (IT) investments are challenging as they usually have long durations and require significant amount of capital expenditure. Given the high uncertainty inherent in these investments, traditional tools are proven insufficient to identify the true values. On the other hand, real options analysis (ROA) is a powerful valuation tool that put emphasis on the ‘real options’ of projects. However, most IT managers do not have the necessary skills to carry ROA. In this paper, we give introduction of ROA and propose an easy-to-use framework for using ROA to value investment opportunities. In addition, we discuss common types of real options and describe a case study of deferral option in a real-world investment opportunity. This paper should serve as a good starting point for managers who want to put ROA into practice.