An Options Approach to Setting Risk Adjusted Hurdle Rates

Abstract

Abstract This paper presents an analogy which indicates chat real investment opportunities can be valued by using generally available formulas for the valuation of securities option. The analogy also indicates that the decision of when to undertake a real investment opportunity is analogous to the decision to exercise an option. Just as option should not be exercised as soon as they are “in the money”, real investment opportunities should be deferred until they show a sufficiently high net present value or excess return. Optimal hurdle rates are derived from formulas for the valuation of securities options.