Making Real Options Real

Abstract

NPV and economic profit (EP) ignore an important reality: business decisions in many industries and situations can be implemented flexibly through deferral, abandonment, expansion, or in a series of stages that in effect constitute real options. Recognizing real options can help decision makers assess the profitability of new projects and understand whether and when to proceed with the later phases of projects that have already been initiated, particularly when they are close to breakeven. Real options are especially valuable for projects that involve both a high level of uncertainty and opportunities to dispel it as new information becomes available.

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