Capital Budgeting for Interrelated Projects: A Real Options Approach

Posted: 6 Aug 1998

See all articles by Paul D. Childs

Paul D. Childs

University of Kentucky

Steven H. Ott

University of North Carolina (UNC) at Charlotte - Department of Finance & Business Law

Alexander J. Triantis

Johns Hopkins University - Carey Business School; University of Maryland - Robert H. Smith School of Business

Abstract

This paper explores the effect of project interrelationships on investment decisions and project values in a real options framework. We examine in detail the mutually exclusive case where a firm may invest in the development stage of two projects and then may select only a single project to implement. The firm can develop the projects in parallel or in sequence. The choice of development policy depends on the relative values of the embedded options for each strategy. Sequential development is shown to be superior to parallel development when projects have highly correlated values, and when they require a large commitment of capital for development, are short term in nature, and have relatively low volatility. We also show that the optimal ordering of sequential projects does not always begin with the most profitable project.

JEL Classification: G31, G32

Suggested Citation

Childs, Paul David and Ott, Steven H. and Triantis, Alexander J., Capital Budgeting for Interrelated Projects: A Real Options Approach. Available at SSRN: https://ssrn.com/abstract=103769

Paul David Childs (Contact Author)

University of Kentucky ( email )

College of Business & Economics
Lexington, KY 40506-0034
United States
606-257-2490 (Phone)
606-257-9688 (Fax)

Steven H. Ott

University of North Carolina (UNC) at Charlotte - Department of Finance & Business Law ( email )

9201 University City Blvd.
Charlotte, NC 28223
United States
704-687-2744 (Phone)
704-687-6987 (Fax)

Alexander J. Triantis

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

University of Maryland - Robert H. Smith School of Business ( email )

Department of Finance
College Park, MD 20742-1815
United States
301-405-2246 (Phone)
301-314-9157 (Fax)

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