A Simulation-Based Investment Justification for an Advanced Manufacturing Technology with Real Options

Abstract

Strategic investment projects such as advanced manufacturing technology (AMT) projects are considered to provide a company benefits beyond the immediate cash flows as well as a variety of real options that are conceived to increase their value. Traditionally, discounted cash flow (DCF) techniques have been widely used to evaluate the value of the investment projects. However, investment analysts have reduced their dependence on the use of the DCF techniques mainly because they believe that the DCF techniques lack in ability to value the real options embedded in the investment projects. As required, the real options approaches (ROA) have been proposed as the complementary for the DCF techniques. In this paper, taking a real case we present how to evaluate the value of the investment projects for the AMT involving a deferral real option with a ROA. For this purpose we first obtained the processing-related data by simulating the underlying manufacturing system. And product cost information was collected under the context of an activity-based costing (ABC) system. Based on the result of the case study we performed we suggest that the investment analysts should be careful in choosing the investment justification technique proper for the projects of interest because there may exist a great amount of difference in the value of investment projects depending on which technique is used.