Managing Risks of Supply-Chain Disruptions: Dual ... - CiteSeerX

Real Options are therefore worthwhile as they allow to take advantage of opportunities and tomitigate downsides. But they can also improve company’s strategies in other ways. For example,thinking in term of real options emphasizes the logic of opportunism; managers are led to considerall the possible opportunities can come with an investment. Finally, it “promotes strategicleverage” as it forces managers to “exploit situations where incremental investment can keep theircompany in the game”. (Leslie and Michaels, 1997).4.2 Real Option ValuationTraditional valuation techniques fail to capture adequately the value of the real options. Thischapter first explains the flaws of traditional NPV, and then presents some different techniques ofreal options valuation.4.2.1 Traditional NPVIn order to evaluate a project, firms usually use the Net Present Value analysis. Brealey and Myersdefine NPV as a project’s net contribution to wealth – present value minus investment. “When wecalculate a project’s NPV we are asking whether the project is worth more than it costs. We areestimating its value by calculating what its cash flows would be worth if a claim on them wereoffered separately to investors and traded in the capital market”. This method values futureexpected cash revenues and investments at a common date, and the NPV is given by the followingformula:NPV = Present Value (Revenues) - Present Value (Investments)(1)In order to estimate the present value, cash flows are discounted at a discount rate r.NPVFCFnttt=1 (1 + r)= ∑− I0(2)with: - n: project lifetime- FCFt: Free-Cash-Flows of year t- r : discount rate36