Assessing the Option to Abandon an Investment Project by the Binomial Options Pricing Model

Abstract

Usually, traditional methods for investment project appraisal such as the net present value (hereinafter NPV) do not incorporate in their values the operational flexibility offered by including a real option included in the project. In this paper, real options, and more specifically the option to abandon, are analysed as a complement to cash flow sequence which quantifies the project. In this way, by considering the existing analogy with financial options, a mathematical expression is derived by using the binomial options pricing model. This methodology provides the value of the option to abandon the project within one, two, and in general n periods. Therefore, this paper aims to be a useful tool in determining the value of the option to abandon according to its residual value, thus making easier the control of the uncertainty element within the project.

Internet of Things and Their Coming Perspectives: A Real Options Approach

“…The present value of the option to expand the investment in digital technologies by a percentage x E at moment n, and by using a continuous stochastic process, is given by [68,69]:…”

“…and q = 1 − p, respectively [68]. Thus, the upper value would define the profitable scenario, whilst the lower value would define the non-profitable one.…”

A mathematical approach to the deferment option of an investment project

“…The initial success of innovative projects, for instance, Google, Xiaomi, or Uber, is often not very clear in early stages because identifying the opportunities to grow is complex; moreover, they allow limiting the risk of losing given that the managerial team may decide whether or not to invest in the project at various stages of its development.More specifically, the option to defer can be considered as a call option because both instruments represent the right but no obligation to purchase an underlying asset at a future date. The main difference between both instruments is that the option to its defer is associated with real assets that include the possibility of its commencement in the future and the call option is associated with financial assets (Cruz Rambaud & Sánchez Pérez, 2016).…”

Decision support for firm performance by real options analytics

“…It is generally recognised that despite advantages referred to in the literature, for example, McGrath () and Luehrman (), about adopting real options methods for managing flexibility, many businesses fail to do this in practice, see Baker, Dutta, and Saadi (). Cited reasons for the failure to adopt and/or the infrequent use of real options include implementation obstacles, organisational complexity, lack of familiarity, and too much sophistication, see Rambaud and Sánchez Pérez (), Driouchi and Bennett (), and Block ().…”

“…Although contemporary applied research in the area of real options has been progressive, it has tended to limit its focus to valuing real options, based on specific investment characteristics (Rambaud & Sánchez Pérez, ; Sarkar, ; Wang & Dyer, ), or to testing the performance implications of real options logic or their usefulness (see Gong, Van Der Stede, & Young, ; Klingebiel & Adner, ; Power & Reid, ). We hold that greater emphasis should be put on exploring investment appraisal techniques for managing a portfolio of real options.…”