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The Engineering Economist: A Journal Devoted to the

Problems of Capital Investment
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A review of: “REAL OPTIONS: MANAGERIAL FLEXIBILITY

AND STRATEGY IN RESOURCE ALLOCATION ” BY LENOS
TRIGEORGIS The MIT Press, ISBN: 0-262-20102-X., xiii +
427 pp. List: $52.95.
a
RICHARD H. BERNHARD
a
North Carolina State University
Published online: 31 May 2007.

To cite this article: RICHARD H. BERNHARD (2000) A review of: “REAL OPTIONS: MANAGERIAL FLEXIBILITY AND
STRATEGY IN RESOURCE ALLOCATION ” BY LENOS TRIGEORGIS The MIT Press, ISBN: 0-262-20102-X., xiii + 427 pp. List:
$52.95., The Engineering Economist: A Journal Devoted to the Problems of Capital Investment, 45:2, 182-184, DOI:
10.1080/00137910008967545

To link to this article: http://dx.doi.org/10.1080/00137910008967545

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 H.BERNHARD
RICHARD
North Carolina State University
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~ A L MANAGERIAL
OPTIONS:
AND STRATEGYIN RESOURCE
FLEXIBILITY
ALLOCATION

The MIT Press, ISBN: 0-262-20102-X., xiii + 427 pp. List: $52.95.

This excellent monograph, not previously reviewed in The Engineerin?

Economist, should be very high-priority reading for. all scholars and
academically inclined practitioners of engineering economics who have not
already studied it. The author, Lenos Trigeorgis, has, for more than 15 years,
been a pioneering researcher in the emerging field of "financial engineering,"
with particular emphasis on applying concepts from financial options theory to
the heretofore largely ignored problem of valuing future flexibility in real asset
investment decisions.
Most recent books on this important topic, even those misleadingly labeled
"introduction to ..." have been abstract, opaquely-written mathematical
treatises, largely inaccessible to many members of the engineering economy
community, all of whom should, indeed, be learning the revolutionary, highly
relevant and useful concepts involved. Dr. Trigeorgis' book does a superb job of
helping to correct this problem. He writes in a lucid, informative, well-
organized, motivated and explained style. In the few places where he does cover
somewhat more difficult mathematical material, that material is clearly labeled
and can be skipped on a first reading without loss of continuity. Overall, the
author's coverage is quite comprehensive, including not only treatment of his
own fine research work but also excellent explanations of the work of many of
the other major contributors to the literature of the field. In addition, he provides
numerous informative footnotes and an excellent bibliography. The book's only
 real shortcoming is that, for use as a text, it does not contain any end-of-chapter
problems for student solution.
The book is nicely organized into 12 largely self-contained chapters that can
be read, with comprehension, in almost any order and without reference to the
others or to any outside sources. Chapter I, Introduction and Overview, gives
lucid examples of the flexibility in real options to defer, expand, contract, shut
down and restart, abandon, switch, etc., and the failure of traditional discounted
cash flow analysis to value this flexibility properly. Chapter 2, Traditional
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Capital Budgeting, gives an excellent survey of net present value under

certainty, including Fisherian graphical analysis, and of conventional methods
for handling risk, including adjustment of discount rates, certainty equivalents,
the capital asset pricing model, sensitivity analysis, simulation and decision
trees.
Chapter 3, Option-Pricing Theory and Financial-Options Applications, very
clearly explains the basic concepts and tools of financial option-pricing theory
and contingent-claims analysis, including puts and calls, replication with
synthetic options and risk-neutral valuation and its usefulness. It also briefly
introduces other more advanced topics, including valuation with discrete-time
multiplicative binomial processes and continuous-time Black-Scholes options
pricing. Chapter 4, A Conceptual Options Framework for Capital Budgeting,
clearly, though relatively abstractly, sets the stage for the rest of the book. Then
Chapter 5, Quantifying Flexibility' in Capital Budgeting: Discrete-Time
Analysis, and Chapter 6 , Quantifying Flexibility: Some Continuous-Time
Analytic Models, take those respective topics, already introduced in Chapter 3,
and develop them much more thoroughly, but still quite clearly.
Chapter 7, Interactions among Multiple Real Options, clearly explains why,
regrettably. valuations of multiple options in a single project are not, in general,
additive and illustrates how to deal with that fact. Then, in a change of pace,
Chapter 8, Strategic Planning and Control, introduces an options-based
framework for planning and control of multiple related projects, and Chapter 9,
Competition and Strategy, deals, somewhat abstractly, with the author's options-
based approach for making valuations under exogenous and endogenous
competition.
Chapter 10, Numerical Analysis, returns to the main theme of the book with
a very nice discussion of various standard numerical procedures for actually
solving complex options problems when, under realistic assumptions, analytical
solutions are not available. With the spectacular recent advances in computer
speed and capacity, this is a topic of enormous current interest and importance,
Chapter 1 I , Applications, one of the best in the book, explains in some detail, a
 number of recent real options applications, e.g. to valuing potential growth, land
development, use of natural resources, and lease and buy options. It also gives
explicit citations of many other options-based applications more fully described
elsewhere in the published literature of the field. Finally, Chapter 12,
Conclusions and Implications, reviews the contents of the book, emphasizes the
basic idea, developed throughout, that the conventional, static net present value
index should be expanded to include an "option premium" and considers
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appropriate directions for hrther research.

Overall, Dr. Trigeorgis' book is superbly well done, a delightful and,
regrettably, thus far, uniquely valuable addition to the literature on options-
based analysis in capital investment planning. I have specified it as a reference
in my first course on "financial engineering" at the graduate level, and I strongly
recommend the reading and study of it by all analytically-inclined theoreticians
and practitioners in the field of engineering economics analysis. The concepts
and ideas discussed by Dr. Trigeorgis really should be very much more broadly
used in the work of our profession.