Research On The Application Of Real Options In Investment Decison-making

The traditional investment decision analysis methods, such as net present value method(NPV), have been viewed as an effective way to think about corporate investment decisions. However, it can not properly deal with the valuation of project investments. This is because that many unrealistic assumptions are needed in the application of these traditional methods. It is thesefore necessary that a new investment decision analysis method (the real option pricing theory) is investingated in this paper.The paper is organized as follows.Section I introduces the question(In the actual marketplace, the traditional NPV method is inadequate in investment decision), and provides a new approach (A method based on the real option).Section 11 discusses the concept, characteristics and category of real options. First, it provides a general introduction of relative knowledge of option, it further presents the basic concept of real options and its development. Second, it compare real options with financial option, summarizes that real options are characterized by non-monopolization, non-tradable, pre-emptive and correlative. An example is then used to conceptually discuss the basic nature of the various real options that may be embedded in capital investments.Section III illustrates the binomial approach and how it can be used in the decision-making. First, it shows the deduction principle and process of one-stage binomial approach, then extends the caculation steps to multi-stage, Second, it uses examples to motivate discussion of pricing of various real options and compare the project value with the outcome of traditional NPV method, it concludes that real option analysis is a more insightful way to think about corporate investment decisions.SectioniV illustrates the Black-Scholes pricing model and how it can be used in the decision-making. First, it gives the basic assumptions and conclusions of Black-Scholes pricing model, Second, it says the feasibility of using the Black-Scholespricing model to price the real option, and compare the relative parameters of financial options with that of real options. Third, it develops examples to explain the application of Black-Scholes pricing model in investment decision-making.