REAL VALUATION

OPTION AND
FINANCIAL OPTION
 REAL VALUATION OPTION
● The real option is the right to make a business decision.
● It does not constitute an obligation to choose that decision. It also represents the decision
alternative available for a tangible asset. Through these options, companies can evaluate various
choices.
● Based on that evaluation, they can choose the right one this way, companies can ensure future
growth and expansion.
● With the real options concept, companies can examine a range of possibilities. Once they do,
they can make a choice that is the most beneficial.
● These options allow managers to analyze and evaluate business opportunities. Doing so is
crucial for long-term profitability. The real options concept applies to investments and projects.
Therefore, they are critical in investment appraisal.

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 DOES THE REAL OPTION WORK?
Real options allow managers to make decisions in several areas. Through these options, managers
can choose between various investment opportunities.
The real options do not oblige them to make a choice. Similarly, it provides them with the
opportunity to invest at once or wait for better conditions in the future.
Real options are also a part of real options value analysis (ROV).

Real options value analysis involves estimating the opportunity costs of various decisions. With this
analysis, managers can evaluate whether to continue a project or abandon it. A real options analysis
begins with managers reviewing the risks related to a project. Based on that, they develop models for
these risks.

A real options analysis allows managers to be more precise with their decisions. They must evaluate
several options and choose an outcome that helps with growth and profitability.
 ADVANTAGE AND DISADVANTAGE OF
REAL VALUATION OPTION
ADVANTAGE
● it allows companies to analyze the value of
flexibility and learning through quantitative
analysis.
● It also provides a structured approach to
visualize the concept of adaptive
management.
● it can guide the timing of adaption
interventions.
● allows companies to use qualitative
information in decision-making.
DISADVANTAGE
● Implementing this analysis involves costs.
For some companies, these costs may exceed
the benefits associated with the process.
● It requires significant volumes of data and
resources. Because this process also leads to
subjective valuations, which may not be
ideal.
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 EXAMPLE OF REAL OPTION

A company, Red Co., considers a project that will provide a positive NPV of $1 million. However,
it can expand its operations through those funds. The expansion process would require more time
as well. On top of that, it would also require additional funds to finance the project. Red Co. can
choose between the project or expanding its operations.

The real options, Red Co. can evaluate the choices it has. This process involves assessing
both projects and how they will impact their operations. Ultimately, the decision will lie
with the company’s management. In most cases, it will choose the option with the best
outcome.

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CONCLUSION
Real options provide companies with the
right to make a business decision. These
options apply to tangible assets rather than
financial instruments. With these options,
companies can evaluate various choices.
Based on that evaluation, they can select the
option with the most beneficial outcomes.
Real options also involve real options
valuation.

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 FINANCIAL OPTION

● Derivative contracts that get their value from an underlying financial instrument.

● It may include stocks, bonds, or even an interest rate.

● Instead of relating to decision-making, financial options provide holders with the

opportunity to buy or sell the underlying financial instrument. These options also
come with a time and price specification.

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 2 TYPES OF FINANCIAL OPTION
● Call Options- give holders the right to buy the financial
instrument at a specified price at a specified future date.

● Put options- come with the right to sell the underlying

financial instrument.

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 DOES THE REAL OPTION WORK?
Financial options are prevalent on the stock exchange.

They may also come over the counter.

Holders can use financial options to hedge against risks or increase their future gains.

Unlike real options, financial options don’t get their value from capital budgeting techniques. Instead,
they consider several variables.

Financial options are derivatives that involve an underlying financial instrument. These do not apply
to the decision-making process, unlike real options.
CONCLUSION
Real options include derivatives that get their value from
future decisions.

These give the holder the right to make a decision in the

future.

Financial options are derivatives that get their value

from underlying financial instruments, such as stocks or
bonds.

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