1) The document discusses using real options theory to value flexibility in business projects and infrastructure development facing uncertainty. 2) Real options theory models how managerial flexibility, through options like expanding, contracting, abandoning or deferring projects, can add value above traditional net present value approaches. 3) The research analyzed an option to expand highway capacity in the Netherlands and found flexibility provided value by lowering costs compared to a rigid construction project.

1. Real options in
business cases
J.G. (Joost) van Blokland MSc (CME), MSc (BA)
NETLIPSE Network Meeting Vienna
September 28th 2010

2. Real Options in Business Cases
Introduction
• Master Thesis on Real Options in Area Development
projects
– Business Administration
– Construction Management and Engineering
AT Osborne University of Twente

3. Real Options in Business Cases
Introduction
Area development Real Options
Uncertainty Flexibility

4. Real Options in Business Cases
Contents
• Project Value
• Real Option Theory
• A2 Amsterdam - Utrecht highway
• Research Results
• Real Options in Projects across Europe

5. Real Options in Business Cases
Project Value
Given the estimated future cash flows of a
project, how do we determine the value of
a project?

6. Real Options in Business Cases
Project Value
• Net Present Value Method
• Determines the value of an investment project based on
future cash flows and the amount of uncertainty within
the investment project

7. Real Options in Business Cases
Project Value
What is the effect of uncertainty
on the value of a project?

8. Real Options in Business Cases
Project Value
• According to the net present value method
project
value
NPV
uncertainty

9. Real Options in Business Cases
Project Value
What would be the effect of managerial
flexibility on the value of a project?

10. Real Options in Business Cases
Project Value
• According to Amram & Kulatilaka (1999)
project
value Managerial options
add value
uncertainty

11. Real Options in Business Cases
Real Option Theory
• Financial option: a predetermined right, but not the
obligation, to buy (call) or sell (put) assets against a
predetermined price (strike price) at a certain moment or
during a certain period
option contract
buyer writer
option premium
€

12. Real Options in Business Cases
Real Option Theory
• Stewart Myers:
“The value of a company is determined by
the value of its current real assets which
have market values independent of the
firm’s strategy and by the present value of
its possibilities to purchase real assets on
possibly favourable terms”

13. Real Options in Business Cases
Real Option Theory
• Real Option:
– Possibility to adjust a project
– Value of the real option is based on a physical object
or action
– Valuable if it is possible to adapt the project when
more information on uncertainty becomes available
– Exists implicitly in a project or is created by an
investment

14. Real Options in Business Cases
Real Options Theory
• Exit options: abandon EXIT
• Timing options: defer, delay
• Scaling options: contract, expand
• Flexibility options: switch
• Complex options: compound + +

15. Real Options in Business Cases
A2 Amsterdam - Utrecht highway

16. Real Options in Business Cases
A2 Amsterdam - Utrecht highway
• Option type option to expand
• Uncertainty demand for road traffic
• Option premium marginal costs for sixth lane
• Strike price change of road signs and re-painting
• Option value saved overhead costs for sixth
lane construction project

17. Real Options in Business Cases
Research results: Decision Support System

18. Real Options in Business Cases
Research results: strategic planning
• Strategic planning based on scenarios (uncertainty), real
options (flexibility) and decision making process (time)

19. Real Options in Business Cases
Research results: conclusions
• Flexibility makes it possible to increase the likelihood of
achieving project goals despite the uncertainty in the
project.
• In almost every investment project, real options can be
created or preserved
• Proactively determining when and how to make use of
these real options adds the value of flexibility to a
project’s business case.

20. Real Options in Business Cases
Remarks! Questions?
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Vragen?