Making Real Options Valuation a Real Option

When it comes to valuing projects in highly uncertain business environments, real options valuation (ROV) isn’t popular as a management tool despite having long been touted as a best practice in academic circles. Seeking to understand why industry has failed to adopt this best practice, the authors interviewed valuation specialists in finance, consulting, and the mining industry. This article aims to help more industry players see ROV as, well, a real and valuable option by highlighting the case for using real options in highly uncertain business environments and offering recommendations on how to effectively deploy ROV. The authors found that the poor adoption of ROV occurs for three key reasons. First, it happens due to a lack of managerial expertise and knowledge. Second, the ROV computation process is highly complex. Third, communication issues exist because the outcomes of ROV are not easily understood without strong knowledge of the underlying concepts. To overcome these limitations and promote the use of real options, the authors present three recommendations: improve training and education, practice greater transparency, and communicate clearly. In order to facilitate these three recommendations, the authors have developed a new ROV software tool to value commodity-producing projects such as mines or refineries. Their Monte Carlo simulation method approximates the ROV by determining the optimal exercise strategy, enabling users to model complex real options problems that include multiple stochastic variables, early exercise rights, and operational flexibility.

• Real Options Valuation, capital investment decision making, ROV analysis, managing dynamic operating environments