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Updated: Jul 1, 2026
13:04
Measuring the Subjective Value of Risky and Ambiguous Options using Experimental Economics and Functional MRI Methods
Published on: September 19, 2012
Making real options really work
Alexander B van Putten1, Ian C MacMillan
1Triad Consultants, USA. alexvp@wharton.upenn.edu
Harvard Business Review
|December 21, 2004
Summary
Real options complement discounted cash flow (DCF) analysis for valuing growth opportunities. Integrating both methods helps managers select better projects and outperform competitors.
Area of Science:
- Finance
- Corporate Finance
- Investment Appraisal
Background:
- Real options valuation is underutilized by managers due to perceived overvaluation of risky projects.
- Discounted cash flow (DCF) analysis alone may underestimate project value and lead to underinvestment in promising opportunities.
- Current real options methods often neglect risks associated with project costs and residual assets.
Purpose of the Study:
- To propose an integrated approach combining real options and DCF analysis for project valuation.
- To address limitations in current real options application, specifically regarding cost risks and asset valuation.
- To provide managers with a tool for improved project selection and risk management.
Main Methods:
- Development of a simplified formula to integrate DCF and real options valuations.
- Addressing the underestimation of project value by considering both revenue and cost uncertainties.
- Incorporating the value of assets from initial investments in abandoned projects.
Main Results:
- The integrated approach provides a more comprehensive project valuation than DCF or real options alone.
- Managers can better assess and manage risks associated with both revenues and costs.
- The method accounts for the value of assets retained after project abandonment.
Conclusions:
- Combining DCF and real options offers a superior method for valuing growth opportunities.
- This integrated approach enables managers to make more informed investment decisions.
- Adopting this valuation strategy can lead to enhanced long-term financial performance and competitive advantage.
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