Real Options and Real Engineering Projects

Abstract: Real options analysis is a tool that has not fully justified itself in the face of real world complexity. It is intended to value flexibility in future choices; however, much of the literature focuses on the mathematical details of how to perform real options analyses, without taking the time to ask whether key characteristics of engineering projects have been properly recognized. In addition, many papers contrast real options analysis with a simple NPV analysis with deterministic data and no options. Because engineering economic analysis has long included decision trees, sensitivity analysis, simulation and other tools, the key question is, what does real options analysis add to this toolbox? A comparison of real and financial options and case studies of engineering projects led us to conclude that the value of real options is more limited than many suggest. Different recommendations due to the use of real options may be limited to near-zero NPV projects where the future benefit stream can be well forecasted and where uncertainty can be identified. This can lead to great difficulty in applying options to real engineering projects.

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