Looking at the Value of an One-Step Deferral Option Through the Opportunity Cost Concept

Abstract

This paper is concerned with exploring the components of the opportunity costs embedded in a deferral options value. It is believed that various kinds of the opportunity cost exist in the deferral options value. With this belief, we performed the work with the assumptions postulated for the general binomial lattice model developed by Cox, Ross, and Rubinstein (CRR model). Under which the real investment project is delayed by one year only for the pedagogical purpose. The three different opportunity costs embedded in the real options value (ROV) were identified: an interest earning opportunity, an opportunity loss, and an expected opportunity gain. With these opportunity costs considered together with other components like the net present value (NPV), we will present the opportunity cost model for one-year deferral option value. A short numerical example is presented to demonstrate that the opportunity cost model provides the same value as with the CRR model. Sensitivity analysis to each of the components made up of the strategic net present value (SNPV) is performed with respect to the risk-free interest rate. As a result of the sensitivity analysis, the interesting fact was found that the ROV increased up to some risk-free interest rate and thereafter it decreased. We explain in more detail the several more interesting facts in the section of the sensitivity analysis.