Study On The Application Of Real Options Approach To Project Valuation

Despite of its popularity, discounted cash flow (DCF), the traditional financial decision-making approach, fails to consider flexibility in real investment cases. It assumes a static and one-time decision-making process. Real options approach offers investors a fresh view by employing the ideas embedded in "options" into valuation for physical assets. It allows flexibility and tracks the real decision making process in a dynamic way. Real options approach is complicated in nature but of broad application. This paper begins with basic concepts and main types of real option then highlights its derivative advantages over traditional DCF approach. A detailed case is employed to illustrate its practical process in three steps: a) DCF application; b) real options recognition and valuation; and c) test and review. ?At last, this paper indicates difficulties confronted by real options approach in application and tries to figure out its possible implications in the financial arena.