Application Of Option Pricing Theory On Project Investment Decision-making

Because of the acceleration of uncertainty in the market, the traditional investment decision-making method did not adapt to the demand of modern project management any longer. The traditional method never considers the uncertainty of future profit and cost encountered by the majority investment decision-making. This method also ignores the fact that the decision-maker can choose the timing of investment. According to the traditional method, investors can only make "rigid" decision, that is to say they can only make decision between "invest now" and "invest never". The traditional method neglects the sunk cost of the majority investment. Once the original cash was invested, it can never be taken back entirely because the investment is irreversible. All those called for the generation of new method of investment decision-making. The option method fits in with the need. The breakthrough of financial option theories in 1980s made it possible to apply the theory to real assets. And the reasonable solution to uncertainty of option theory makes its application to real assets be the research trend of many researchers. Under this circumstance, this paper discusses the application of option theory to investment decision making.Firstly, this paper introduces the researching background and object, mainly introduces the development of investment decision-making method and its present research situation abroad and domestic. After introducing the vital defects of the traditional method, this paper points out the option characteristics in investment decision-making and the importance of applying the option method in decision-making. In Chapter 3, in order to make the elementary theories understood, this paper starts from the basic concepts, introducing the fundamental theories of financial option, which contains two option pricing model and their appraisal. After that, this paper studies the deficiency of financial option theories applying to real assets, and modifies and improvesthe said two option pricing models. Based on all those theory preparations, this paperproceeds with the most important part of our research——the application of optionpricing theory to investment decision making(Real Option). After building the application frame, this paper introduces different kinds of real option, and gets the conclusion that option method is the best complementary to the traditional method. In the next Chapter, this paper discusses deficiency of option method, and gives the concrete improvement suggestion. At last, in Chapter 7, this paper make sum-up, and indicates the future researching direction.This paper adopts the prescriptive approach to proceed with the research of option pricing theory and its application, and gets the following conclusions:(1) The traditional method fails to solve the problems of uncertainty and management flexibility in the investment decision-making, and unable to accommodate itself to modern investment decision-making.(2) The reasonable solution to uncertainty and value of flexibility by the option method in the investment decision-making makes it be the best complementary to the traditional method.(3) The utility of the application of option method is determined by the input values of option pricing model.