The Smith Company: A Case on Capital Budgeting and Real Options

Abstract

This (fictitious) case focuses on differences between using a straightforward net present value (NPV) analysis of a proposed capital budgeting project and a real-options analysis. To complete the case, students are required to have some background in the pricing of financial options, including the Black-Sholes-Merton (BSM) options-pricing model. An appendix to the case provides a review of real option valuation, including a discussion of the use of simulation to estimate cash-flow volatility and to perform sensitivity analyses. By design, the case covers all current requirements for real options specified for the Certified Management Accounting (CMA) exam (IMA, 2008). The case could be used in an upper-level undergraduate cost/managerial accounting course, an MBA managerial accounting course that covers the topic of capital budgeting, or a graduate accounting course that focuses on financial risk management.