Are “Real Options” Actually Used in the Real World?

Block, Stanley B.

doi:10.1080/00137910701503910

Cited by 104 publications

(101 citation statements)

References 9 publications

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“…Contrary to Copeland and Antikarov (2001) prediction that real options would dominate the capital budgeting process by the next decade (2011), Baker and Dutta (2011) recorded in 2011 that only 36 out of the 214 respondent firms they sampled from 847 Canadian companies listed on the Toronto Stock Exchange (TSX) used real options, representing 16.8%. A similar result was recorded by Block (2007) in the United States where, out of 279 respondents sampled from the Fortune 1000 companies, only 40 were using real options, representing a paltry 14.3%. In Australia, Truong et al (2008) carried out a similar study with 356 firms listed on the Australian Securities Exchange (ASX), and they observed that out of the 87 respondents, 28 firms used real options in capital budgeting, an improvement over the other two countries.…”

Section: Background To the Researchsupporting

confidence: 55%

“…Block (2007) observed in his survey that 31.7% of the respondents attributed their lack of interest in real options to the sophistication in the models as well as the risky nature of the assumptions used. Cotter et al (2003) also identified implausible mathematical assumptions as the major hindrance in the adoption of real options in capital budgeting decision-making.…”

Section: Background To the Researchmentioning

confidence: 99%

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Reasons why Real Options Analysis (ROA) is not widely adopted in the mineral industry

Ampofo¹

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Real options analysis (ROA) is an advanced technique for valuing mineral projects that generates more useful information for decision-makers in the mining industry than that generated using discounted cash flow (DCF) method, yet the latter is much more commonly used in the industry. Why?The answer to this question motivates the thesis.The slow adoption of ROA in the mineral industry has been investigated by several researchers.The outcomes of these previous studies have had minimal impact on the industry because these researchers adopted an approach that focused solely on the quantitative shortcomings of ROA. Until now, little empirical evidence existed on the qualitative reasons that impede the mainstream adoption of ROA as a valuation technique in the mineral industry in spite of its well-established advantages.This thesis advances a series of innovative solutions to address this gap. First, it develops a novel system approach to ROA based on practical assumptions. Secondly, it applies this system approach to a real mine case study to identify the value-added information generated by the ROA method compared with the DCF method. Finally, based on the case study output, the study engages industry experts to identify the qualitative reasons for the relatively low uptake of ROA in the mining industry.In developing the novel system approach to applying ROA, the study focused on building a framework that incorporates realistic modelling of project uncertainties, careful modelling of the value of mineral assets and development of a user-friendly end-user tool that simplifies the process. The system real options (SRO) tool was developed using Matlab to estimate the economic value of projects using ROA. SRO reduces the complexity in ROA application and integrates the method with Monte Carlo simulation and statistical distributions to enable mineral projects under uncertainty to be realistically valued and optimised.To identify the additional information that ROA generates over the DCF method in mineral project valuation, SRO was used to re-value a gold mining project, Adinkra Mine, initially valued using the DCF method in 2004. The initial DCF method valued the project at $493 million; however, SRO recorded a $528 million mean project value with a 62% probability of the project returning a higher value than the DCF value. In addition, the value of the option to expand the mine's capacity was i analysed using the SRO tool to guide the company in its strategic decision-making. Subsequently, the company's country expansion program was assessed using SRO to determine the value of each project under different in-country scenarios. The results of the DCF and ROA were statistically compared with the actual (real) project outputs from 2004 to 2015. The results indicated a higher correlation between the actual (real) project outputs recorded from 2004 to 2015 and the valuation results recorded using the ROA method. In addition, using the ROA approach enabled useful information to be generated that showed significant pot...

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Section: Background To the Researchsupporting

confidence: 55%

Section: Background To the Researchmentioning

confidence: 99%

Reasons why Real Options Analysis (ROA) is not widely adopted in the mineral industry

Ampofo¹

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“…Albeit this potential of real options valuation, numerous studies have shown that many firms do not explicitly incorporate the real options approach in allocating R&D resources (e.g., Baker et al 2011;Bennouna et al 2010;Block 2007;Graham and Harvey 2001). However, in some industries like the pharmaceutical sector, real options analysis seemingly found its place in the method set as an auxiliary valuation tool: 1 Hartmann and Hassan (2006), in their study of leading international research-based pharmaceutical and biotech companies, find that roughly one quarter of the surveyed R&D managers use real options analysis as a valuation method.…”

mentioning

confidence: 99%

Modeling sequential R&D investments: a binomial compound option approach

Hauschild

Reimsbach

2014

Bus Res

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In this paper, we propose a binomial approach to modeling sequential R&D investments. More specifically, we present a compound real options approach, simplifying the existing valuation methodology. Based upon the same set of assumptions as prior models, we show that the number of computational steps for valuing any compound option can be reduced to a single step. We demonstrate the applicability of our approach using the real-world example of valuing a new drug application. Overall, our work provides a heuristic framework for fostering the adoption of binomial compound option valuation techniques in R&D management.

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“…by these firms having financial problems, and thus, they may feel they have to uncover investments that quickly recover the initial investment (Daher & Saout, 2015). On the other hand, Block (2007) inferred that financial organizations can exercise indirect pressure on the analytical methods used by companies to make investment decisions.…”

Section: Determinants Of Capital Expenditure At Firm Levelmentioning

confidence: 99%