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Book part
Publication date: 1 May 2012

Andrew H. Chen, James A. Conover and John W. Kensinger

Perhaps the most difficult objection raised by skeptics of the real options approach concerns the apparent lack of market transactions that would verify that real options

Abstract

Perhaps the most difficult objection raised by skeptics of the real options approach concerns the apparent lack of market transactions that would verify that real options have actual value. Although there are no organized exchanges with publicly disclosed prices, there are nevertheless several mechanisms for buying and selling real options. Observing these could offer important advantages in the quest for enhancing the role of real options in financial decision making:•demonstrate that real options can indeed add value•in some cases even gain a sense of the amount of value added by real options•offer expert appraisers methods for improved estimation of the value of a business when real options are part of the organizational capital

The most frequently used method for buying or selling real options occurs when a product that includes real options is sold to customers (often at a premium above the price of a comparable product that does not include real options). Real options that are part of the organizational capital of a business are part of the package in an acquisition (or minority equity position). In this chapter we examine several cases of such transactions.

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Research in Finance
Type: Book
ISBN: 978-1-78052-752-9

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Article
Publication date: 1 February 2001

Dominik I. Lucius

The interpretation and valuation of real options by means of options pricing theory can be regarded as a relatively new paradigm of investment theory. Option pricing…

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6299

Abstract

The interpretation and valuation of real options by means of options pricing theory can be regarded as a relatively new paradigm of investment theory. Option pricing theory based investment valuation represents a sound theoretical basis and offers principally a simple decision base. The approach recognises entrepreneurial flexibility and risk explicitly. It implies a positive correlation between flexibility respectively uncertainty and the value of options. Traditional deterministic‐dynamic standard methods of valuation are not able to value flexibility or risk effectively so that option values are adequately reflected. As property investors gradually embrace modern financial concepts it is clear that real estate valuation theory will have to change. One of the most promising areas that could have an important implication on the further development of valuation is the application of the real options paradigm. The author investigates the transfer of general real options theory through an examination of academic results in the field of real estate development. He comes to the conclusion that current research generates highly academic‐abstract results with limited practical value. So far a limited number of quantitative studies regarding the valuation real estate projects with the real options method have been conducted. Practical valuations have yet to be comprehensively carried out. For doing so, further research concerning the basic prerequisites of real options theory has to be undertaken.

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Journal of Property Investment & Finance, vol. 19 no. 1
Type: Research Article
ISSN: 1463-578X

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Article
Publication date: 11 January 2008

Oliver Yu

The concepts of real options analysis, which transfer options analysis for financial investments to those involving real properties, such as land and plant facilities…

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1391

Abstract

Purpose

The concepts of real options analysis, which transfer options analysis for financial investments to those involving real properties, such as land and plant facilities, have already existed for 30 years. However, the actual application of real options analysis to technology portfolio planning has not been as widespread as expected. Among others, a major barrier to such applications appears to be a lack of appreciation and acceptance of real options by technology executives. This case study aims to present a successful application experience of real options analysis to technology portfolio planning and highlights the lessons learned in overcoming such lack of acceptance and other barriers.

Design/methodology/approach

The paper uses a case study approach. The methodology focuses on describing the key issues and solutions for applying real options analysis in the technology portfolio‐planning process of a company.

Findings

The findings in this paper showed that considerable barriers exist in the acceptance of real options analysis for technology portfolio planning. However, the experience in the case study provides successful approaches for overcoming these barriers.

Originality/value

The paper shows that few studies are available on the difficulties of introducing real options analysis in practical applications. This paper provides a valuable case study for such applications.

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International Journal of Quality & Reliability Management, vol. 25 no. 1
Type: Research Article
ISSN: 0265-671X

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Book part
Publication date: 19 July 2005

Timothy B. Folta

I am interested in clarifying the discussion of how researchers might try to isolate real option effects to identify whether managerial decisions are guided by a real

Abstract

I am interested in clarifying the discussion of how researchers might try to isolate real option effects to identify whether managerial decisions are guided by a real option heuristic. If we are to claim that the theory of real options illuminates managerial behavior, then as a field, we must converge on an understanding as to what constitutes a real option effect, and what does not. The discussion centers on hypothesis development, measurement issues, and research methodology.

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Research Methodology in Strategy and Management
Type: Book
ISBN: 978-0-76231-208-5

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Book part
Publication date: 13 August 2007

Tony W. Tong and Jeffrey J. Reuer

Real options theory begins by drawing an analogy between real options and financial options. A financial option is a derivative security whose value is derived from the…

Abstract

Real options theory begins by drawing an analogy between real options and financial options. A financial option is a derivative security whose value is derived from the worth and characteristics of another financial security, or the so-called underlying asset. By definition, a financial option gives its holder the right, but not the obligation, to buy or sell the underlying asset at a specified price (i.e., the exercise price) on or before a given date (i.e., the expiration date). Financial economists Black and Scholes (1973) and Merton (1973) pioneered a formula for the valuation of a financial option, and their methodology has opened up the subsequent research on the pricing of financial assets and paved the way for the development of real options theory.

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Real Options Theory
Type: Book
ISBN: 978-0-7623-1427-0

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Book part
Publication date: 13 August 2007

Jeffrey J. Reuer and Tony W. Tong

This paper categorizes and critiques the empirical research strategies that have been employed to test real options theory. Existing research has sought to detect valuable…

Abstract

This paper categorizes and critiques the empirical research strategies that have been employed to test real options theory. Existing research has sought to detect valuable options in firms’ strategic investments as well as to investigate the payoffs from these investments. Our review highlights some of the evidence that has accumulated in recent years for real options theory. We flag some of the most important challenges and tradeoffs associated with the use of different empirical research approaches for testing real options theory in strategic management. The paper concludes by offering a number of research priorities to advance the theory by probing its descriptive validity as well as by addressing its normative aspirations to bridge corporate finance and strategy.

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Real Options Theory
Type: Book
ISBN: 978-0-7623-1427-0

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Book part
Publication date: 13 August 2007

Jing Li

The application of real options theory to international strategy has surged in recent years. However, it is still a relatively new and loosely defined field, and there are…

Abstract

The application of real options theory to international strategy has surged in recent years. However, it is still a relatively new and loosely defined field, and there are several constraints on practical applications of this powerful theory. To move forward this field, the paper first provides a systematic analysis of theoretical and empirical contributions of real options theory to three critical issues in international strategy: (1) valuing multinational networks, (2) assessing market entry modes, and (3) evaluating market entry timing. The paper further suggests that future studies can focus on a refined treatment of uncertainty and the development of a dynamic theory in international strategy. Five testable propositions are developed in these directions.

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Real Options Theory
Type: Book
ISBN: 978-0-7623-1427-0

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Book part
Publication date: 13 August 2007

Yong Li, Barclay E. James, Ravi Madhavan and Joseph T. Mahoney

We discuss recent developments in real options theory and its applications to strategic management research, examine the potential difficulties in implementing real options

Abstract

We discuss recent developments in real options theory and its applications to strategic management research, examine the potential difficulties in implementing real options in theory and practice, and propose several areas for future research. Our review shows that real options theory has provided substantial insights into investment and exit decisions as well as into the choice of investment modes. In addition, extant research studies have contributed significantly to our understanding of whether and how organizations can benefit from real options. Future research that addresses difficulties in applications will further advance both real options theory and practice in strategic management. We call for future generations of research to enhance the impact of real options as an emerging dominant conceptual lens in strategic management.

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Real Options Theory
Type: Book
ISBN: 978-0-7623-1427-0

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Article
Publication date: 2 September 2014

Maartje van Reedt Dortland, Hans Voordijk and Geert Dewulf

The objective of this paper is to provide insights about the potential of real option thinking for corporate real estate management (CREM) from the owner-user perspective…

Abstract

Purpose

The objective of this paper is to provide insights about the potential of real option thinking for corporate real estate management (CREM) from the owner-user perspective. A promising approach to classifying and evaluating flexibility in real estate is the real options approach. Most literature on real options look from an investor perspective.

Design/methodology/approach

First, a review on real option thinking in the real estate and large engineering projects literature is provided using Flyvbjerg’s (2001) typology of knowledge systems. Next, the effects of exercising real options for various stakeholders in CREM is analysed in two case studies.

Findings

The literature review shows that little research has been done on conditions and values needed to make real options applicable in the CREM practice of the owner-user of real estate. The case studies show that real options are more valuable to one stakeholder than to another.

Practical implications

Based on the knowledge on conditions for and the consequences of exercising real options for various stakeholders, insight can be gained into the applicability of real options to the owner-user of real estate and how real options reasoning fits within this practice. A phronetic type of knowledge is needed that incorporates stakeholders’ interests.

Originality/value

Creating phronetic knowledge would allow understanding why and how real options are used, or could be used in the future, and heuristics could be developed. In this way, real estate management should become more resilient to changes.

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Journal of Corporate Real Estate, vol. 16 no. 3
Type: Research Article
ISSN: 1463-001X

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Article
Publication date: 2 August 2013

Francesco Baldi

Real options available to developers and leading to an active and dynamic development of real estate assets are numerous. The purpose of the article is twofold. First, a…

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1499

Abstract

Purpose

Real options available to developers and leading to an active and dynamic development of real estate assets are numerous. The purpose of the article is twofold. First, a conceptual framework is proposed as a practical aid for recognizing and understanding some frequently recurring combinations of options (such as deferral and expansion options). Based on the definition and classification of real options available in real estate markets, a comprehensive valuation tool for quantifying the value of those options embedded in a real estate development project is thus developed using a portfolio view.

Design/methodology/approach

Based on standard option pricing techniques, the proposed conceptual methodology is validated by applying it to an actual case of an investment for the construction of a new, multi‐purpose building in the semi‐central zone of the urban area of Rome (Italy).

Findings

Based on a static land value of €34.7 million, a waiting mode (deferral option) at an early stage of developing a property accounts for 16 percent of the expanded land value of the project, with 8 percent of such value being contributed by the expansion option. A real options valuation of the options portfolio available to a real estate developer enables increasing the project value by 31.1 percent as opposed to a traditional DCF analysis. In line with financial options theory, values of real options increase as volatility rises.

Practical implications

The case‐based analysis highlights that: flexibility in real estate development may create additional value enabling real estate developers or funds to react to market trends as new information arrives and uncertainty on fundamental factors (e.g. property prices) unfolds; the extra value added by managerial flexibility is neglected by DCF/NPV techniques; contrary to the common criticism on its lack of rigor, option valuation theory is suitable for appraising real estate assets; a portfolio approach is crucial when multiple real options exist.

Originality/value

Active management of real estate investments in response to changing property market and technology conditions confers operating flexibility and strategic value to appraisal of development projects beyond what is traditionally captured by a DCF model. An options approach to valuing and managing real estate development may change the developer's perspective altogether. Based on the combination of an original classification and a portfolio view of options existing in real estate markets, a real options framework for assessing the value of strategic flexibility incorporated in a greenfield development project (also accounting for potential option interactions) is designed.

Details

Journal of European Real Estate Research, vol. 6 no. 2
Type: Research Article
ISSN: 1753-9269

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