OPTION APPROACH TO CAPITAL INVESTMENT EVALUATION

In finance, the discounted cash fl ow (DCF) model operates as the basic framework for most analysis. In investment analysis, the conventional view is that the net present value of a project is the measure of the value that it will add to the firm taking it. Thus, investing in positive (negative) net present value project will increase (decrease) value. In recent years, this framework has come under some fire for failing to consider the options that are embedded in each of these actions. For instance, the net present value of a project does not capture the values of the options to delay, expand or abandon a project. In light of these options that seem to be everywhere, there are some theorists and many practitioners who belive that we should consider these options when analyzing corporate decisions. The asimmetry deriving from having the right, but not the obligation to exercise the option, lies at the heart of the option’s value.