Abstract
The traditional approach to valuation at th e FAA, other government agencies, and businesses understates the true value of proposed projects. By ignoring the inherent flexibility in these projects, a discounted cash flow analysis may lead to erroneous investment decisions. The real options approach to project valuation, derived from well established financial options pricing theory, can be used to supplement a traditional discounted cash flow analysis. The real options approach, which is beginning to see widespread use in private sector project valua tion, can help managers to design their projects so as to maximize managerial flexibility. Real options can also provide a more realistic estimate of a project’s value and thus lead to improved investment decision -making. This paper describes the real opti ons methodology using a data link case study based on the FAA’s recently postponed Controller Pilot Data Link Communications (CPDLC) project. We will show that there might have been significantly more value in the project than was realized by a naive Net P resent Value (NPV) analysis, had the program been structured to increase managerial flexibility. While our example demonstrates an increase in project present value, it is still insufficient to justify the investment. But we present only one such possible program structure, which is certainly not the optimum. By using real options analysis as a planning tool one could possibly have designed a program that was economically defensible, maximizing flexibility and thereby reducing risk.
Published Version
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