The Promise and Peril of Real Options

75 Pages Posted: 5 Nov 2008  

Aswath Damodaran

New York University - Stern School of Business

Date Written: July 2005

Abstract

In recent years, practitioners and academics have made the argument that traditional discounted cash flow models do a poor job of capturing the value of the options embedded in many corporate actions. They have noted that these options need to be not only considered explicitly and valued, but also that the value of these options can be substantial. In fact, many investments and acquisitions that would not be justifiable otherwise will be value enhancing, if the options embedded in them are considered. In this paper, we examine the merits of this argument. While it is certainly true that there are options embedded in many actions, we consider the conditions that have to be met for these options to have value. We also develop a series of applied examples, where we attempt to value these options and consider the effect on investment, financing and valuation decisions.

Suggested Citation

Damodaran, Aswath, The Promise and Peril of Real Options (July 2005). NYU Working Paper No. S-DRP-05-02. Available at SSRN: https://ssrn.com/abstract=1295849

Aswath Damodaran (Contact Author)

New York University - Stern School of Business ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0340 (Phone)
212-995-4233 (Fax)

HOME PAGE: http://www.damodaran.com

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