Real Option Analysis

Suggestion for business strategies in term of project frame

Every capital project has its project frame. The project frame has four boundaries, which is front, top, bottom, and back. Front boundary represents whether or when should the firm begin the project. Top means what option should the firm use to extend the capacity of the project. Bottom measures the minimum value of the project. If the value is under the bottom, the firm should use real options to reduce the cost. Back means what should firm to do at the ending of the project to extend the life of the project. Real options generate value by providing opportunities to move the sides of the frame.

（上面一部分是梁正写的，下面标黄的是黄子豪写的。你写一点东西连接一下）

Top-Investment timing option: In the beginning of a project, there are two options needed to determine: invest at present, or delay to a feasible time and invest.

Front-Growth option: Also, the capacity of a project will influence the initial investment within two options: limit the project’s capacity in order to reduce the initial investment, or expand the capacity of the project subsequent to the initial investment.

Bottom-Flexibility option: As the construction of a project, technology, purpose and span have diversified alternatives, such as changing technology or the cost structure of the project can regulate the value of this project.

Back- Abandonment option: At the ending of a project, managers need to consider whether this project should extend the life or not based on its profitability.

Compare with traditional expected value analysis

Traditional expected value analysis holds that investments should be made when the net present value of an investment opportunity equals or exceeds zero. And it also assumes that the investment must be made either now or never. However, traditional expected value analysis ignore considering that management can adapt and revise its strategies in response to unexpected market. Up-front research and development could cause cash...