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An Opportunity Cost Model to Value a Deferral Option

Gyutai Kim

Chosun University - Department of Industrial Engineering

Luke.T. Miller

Fort Lewis College

August 1, 2012

This paper discusses the real option valuation approach based on the familiar opportunity cost concept. The model presented decomposes the deferral option value into four contributing components - interest earning opportunity, expected opportunity gain, present value, and investment cost. After demonstrating the equivalence of the opportunity model to Cox, Ross, and Rubinstein’s (CRR) binomial lattice approach, its attributes are discussed through simple numerical examples. In contrast with the CRR approach, the opportunity model’s transparency provides an intuitive and economical baseline for managerial discussion and decision-making. Additionally, the appropriateness of risk-neutral probabilities to value real options is discussed in the context of actual (or real) probabilities. Finally, it should be emphasized that the discussion of the paper be concentrated on the opportunity costs inherently embedded in the real options value, therefore, it is different from other works per se which consider them as the exogenous input to the real options value

Number of Pages in PDF File: 32

Keywords: binomial lattice model, capital budgeting, decision making/process, opportunity cost, real options

JEL Classification: G12,G31

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Date posted: August 1, 2012  

Suggested Citation

Kim, Gyutai and Miller, Luke.T., An Opportunity Cost Model to Value a Deferral Option (August 1, 2012). Available at SSRN: https://ssrn.com/abstract=2121267 or http://dx.doi.org/10.2139/ssrn.2121267

Contact Information

Gyutai Kim (Contact Author)
Chosun University - Department of Industrial Engineering ( email )
3215 The 2nd Building of College of Engineering
375 Seosuk-Dong, Dong-Gu
Kwangju 501-759
82-62-230-7122 (Phone)
82-62-230-7128 (Fax)
Luke.T. Miller
Fort Lewis College ( email )
United States
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