Real Option Method

Compared with the conventional net present value method, which tends to underestimate an investment item due to measurement only with the present value, the real option method has features of measuring as a value flexibility or options for decision making such as postponement, expansion/reduction, and withdrawal of investment, and evaluating the entire value of investment item. These days, the real option method has been increasingly adopted year by year. The difference between the net present value method and the real option method is shown in the example of the following diagram.

If the net present value is analyzed in consideration of occurrence probability (without considering an interest rate generated with the passage of time), the estimated expected value of this project investment is -¥4,000,000, that is, the expected value obtained from the project investment is negative, meaning there is no investment value in conclusion. In such a case, however, the enterprise does not need to take an option of selling products when equipment investment and manufacturing cost exceed the expected sales value, that is, the business obviously shows a deficit. In other words, deficit cases can be cut off. If the option is executed when the development is completed, further losses can be prevented. As a result, the expected value of the project becomes larger, and it is calculated as ¥11,500,000.

(Conditions)

Cost of the product development:

¥10,000,000 ® Essential for development

Cost of equipment investment & manufacturing: ¥60,000,000 ® Occur with the probability of 20% ¥90,000,000 ® Occur with the probability of 30% ¥120,000,000 ® Occur with the probability of 50%

Anticipated sales value:

¥70,000,000 ® Occur with the probability of 50% ¥140,000,000 ® Occur with the probability of 50%

The cost of equipment investment & manufacturing and the expected sales value become clear when the development is completed.

Cost of equipment investment & manufacturing

Expected sales value

Cost of development

Expected sales value

Cost of equipment investment & manufacturing

Cost of development

7.000 J

(Unit: ¥10,000) - - 1,000 + (IDO * ÜOO - 300 + 750 - E.,250 + 500)

14.050

7.000 J

(Not executed)

(Not executed)

(Unit: ¥10,000) - - 1,000 + (IDO * ÜOO - 300 + 750 - E.,250 + 500)

Option

0 0