Real Options and Modern Capital Investment Decisions

Abstract

It has long been recognized that many capital investments feature options. For instance, an assembly plant may be expanded if product demand warrants, a warehouse may be abandoned, and a construction project may be deferred until market conditions are better. It has also been recognized that traditional capital budgeting tools such as net present value and internal rate of return ignore these features. To fill this void, modern option pricing theory has now found its way into the field of capital investment decision making and is referred to as the real options approach to capital budgeting.