Real Options: New Phenomenon in Capital Budgeting
Real Options: New Phenomenon in Capital Budgeting

Summary/Abstract: Dealing with uncertainty of the economic environment on the decision to invest is not new. During the last three decades, a new strand of theory, Real options approach to investment, linking uncertainty and investments, has emerged. This theory is based on the simultaneous existence of three phenomena: uncertainty, irreversibility of investment and some freedom of choice on the timing of investment. Their interaction may generate an opportunity cost equivalent to the exercise of an option. As the article reveals, it adds an important dimension to the neoclassical theory of investment, while this one has not recognized the important qualitative and quantitative implications of this interaction. Moreover, it also explains some of its failures.

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