APPLICATIVE MODEL FOR APPRAISAL OF INVESTMENT PROJECTS BASED ON REAL OPTIONS METHODOLOGY

Abstract

This paper deals with the application of real options methodology on valuation of investmentprojects. The basic objective of the paper is to present applicative project valuation model, whichenables decision-makers to build-up conventional NPV analysis by incorporating key input randomvariables, by using Monte Carlo simulation, and managerial flexibilities, by defining if-then decisionrules. In contrast to most of valuation procedures covered in the literature, presented applicativemodel accepts simple premise that the project value is unknown in advance. Project value is notdisplayed with a single NPV number, but with the cumulative probability distribution. Finalmanagerial decision does not depend on fixed decision rules, but on managerial aversion towardsrisk, i.e. on subjective trade-off between project risks and returns.

Keywords

• investment project
• valuation
• real option