Real option valuation in high-tech firm

Abstract

In traditional financial theory, the discounted cash flow model (or NPV) operates as the basic framework for most analyses. In doing valuation analysis, the conventional view is that the net present value (NPV) of a project is the measure of the value that is the present value of expected cash flows added to the initial cost. Thus, investing in a positive (negative) net present value project will increase (decrease) value.

Recently, this framework has come under some fire for failing to consider the options which are the managerial flexibilities, which are the collection of opportunities.

A real-option model (Option-based strategic NPV model) is estimated and solved to yield the value of the project as well as the option value that is associated with managerial flexibilities. Most previous empirical researchers have considered the initial-investment decision (based on NPV model) but have neglected the possibility of flexible operation thereafter. Now the NPV must be compared with the strategic option value, by which investment is optimal while the NPV is negative. This leads investors to losing the chances to expand themselves.

In the paper we modify the NPV by taking into account real options—theme of this paper, or strategic interactions. R&D, Equity and Joint Ventures will be viewed as real options in practice of case studies of this paper.