Real options in

business cases

J.G. (Joost) van Blokland MSc (CME), MSc (BA)

NETLIPSE Network Meeting Vienna

September 28th 2010

Real Options in Business CasesIntroduction

• Master Thesis on Real Options in Area Development

projects

– Business Administration

– Construction Management and Engineering

AT Osborne University of Twente

Real Options in Business CasesIntroduction

Area development

Uncertainty

Real Options

Flexibility

Real Options in Business CasesContents

• Project Value

• Real Option Theory

• A2 Amsterdam - Utrecht highway

• Research Results

• Real Options in Projects across Europe

Real Options in Business CasesProject Value

Given the estimated future cash flows of a project, how do we determine the value of

a project?

Real Options in Business CasesProject 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

Real Options in Business CasesProject Value

What is the effect of uncertainty

on the value of a project?

Real Options in Business CasesProject Value

• According to the net present value method

project

value

uncertainty

NPV

Real Options in Business CasesProject Value

What would be the effect of managerial flexibility on the value of a project?

Real Options in Business CasesProject Value

• According to Amram & Kulatilaka (1999)

project

value

uncertainty

Managerial options

add value

Real Options in Business CasesReal 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 premium

option contract

buyer writer

€

Real Options in Business CasesReal 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”

Real Options in Business CasesReal 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

Real Options in Business CasesReal Options Theory

• Exit options: abandon

• Timing options: defer, delay

• Scaling options: contract, expand

• Flexibility options: switch

• Complex options: compound

EXIT

++

Real Options in Business CasesA2 Amsterdam - Utrecht highway

Real Options in Business CasesA2 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

Real Options in Business CasesResearch results: Decision Support System

• Strategic planning based on scenarios (uncertainty), real

options (flexibility) and decision making process (time)

Real Options in Business CasesResearch results: strategic planning

Real Options in Business CasesResearch 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.

Real Options in Business CasesRemarks! Questions?

Vragen?? !

?!

!? ?