Named by Stewart C. Myers (Determinants of Corporate Borrowing, 1977), on the option pricing of Fischer Black and Myron Scholes (1973), and developed by Lenos Trigeorgis (Real Options, 1996) and Tom Copeland and Vladimir Antikarov (2001).
Values the right to expand, delay, shrink, switch, or abandon an investment later as uncertainty clears, which a standard discounted cash flow tends to miss.
When to reach for it
Investments that can be staged, where the case for or against changes once the value of waiting or starting small is counted.
How it runs
- Name the decision and the uncertainty that will clear over time.
- List the options it creates: defer, expand, contract, switch, or abandon.
- Calculate the conventional net present value.
- Estimate what the flexibility adds.
- Compare committing now, staging, and waiting.
- Set the triggers for exercising each option.
Where it sits in SOLVE eX
Go to the source
- Determinants of Corporate Borrowing, Journal of Financial Economics, 1977
- The Pricing of Options and Corporate Liabilities, Journal of Political Economy, 1973
- Real Options: Managerial Flexibility and Strategy in Resource Allocation, 1996
- Real Options: A Practitioner's Guide, 2001