Use of Real Options Theory
April 18, 2011nstructor:
At a previous employment environment, the president of the corporation acted on a whim, rather than, conducting a series of testing for his expansion to go into other businesses ventures. Within a few short months, the plan was abandoned for lack of profitability. As an employee, I thought of this as a failure on the owner’s part. However, the Real Options Theory is basically, weighing the outcome for expansion or acquisition utilizing capital investments for future ventures. Consider Real Option theory as a method to remove some of the risk in capital investments. Helpful assistance and decision making can be derived using such charts as the Decision Tree. The decision can be extremely tiresome.
Use of Real Options Theory in Financial Management/Modeling
Long past are the days, where a company can sit idling waiting for an idea, because while waiting someone else is making the move. The benefits that an older company may experience through experience may not fit into today’s society of technological changes. However, the risk of a company that has existed over 50 years, can they lose to new companies that evolve because of revolutionary changes in the ability to change the course of history. Creating valuable service for consumers and bringing a product or service to market, must be planned to meet the expectations of stockholder profits. Consider the comparison of social networking sites, Myspace and Facebook. Both are considered to be rapidly growing and competitive to increasing in membership. However, rapidly increase the popularity of Facebook and exceeded the expectations within the social network environment. The billion dollar corporation enters the market with more appeal to younger consumer, as well as a variety of other industries. Facebook provided more appeal by allowing the markets to meet the consumer where they were located, rather than wait on the consumer to come to them. As financial managers in the corporate environment decide which project is beneficial to stock holders’, returns on investment, and which should be abandoned or expanded, risk can become a certainty in the outcome. The risk of capital investment in the attempt to take on future debts just because they have a hunch that the business will be a success. The amount of time to construct a business model would save enormous amounts of money before taking on the future project. Gathering data of the competitive market and using past financial accounting statements will be useful, however, with new projects, there will be limitations, but estimation of the percentage values can be constructed. Strategic budgeting and capital investment planning decisions to expand into the future profitability of a company can be agonizing if not properly planned by financial managers. The assets, in addition to capital and distribution, change over long periods of time according to the supply and demand of the consumer markets. The net present value (NPV) of what is available, as far as Return on Assets and the Return on Investment (ROI). Cost projection into buying new equipment, inventory over the long run rather than a short period. Capital resources and budgets are the topics as it relates to using the Real Options Theory in Financial Management Modeling. Financial managers can utilize the Real Options Theory as a series of practical solutions to foresee into the future over several years. New products and the amount of capital to invest as well as the funding needed to make an expansion or either to realize that the project would not work. Theoretically, it is very simple and that many companies would utilize this theory. However, the recap or history of business failures is not seen in the futility of business success. The numbers may not lie. All systems may say go full steam ahead...