Use of Real Options Theory in Financial Management/Modeling

Undergraduate
Term Paper
Finance & Accounting
Pages 8 (2008 words)
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This paper is a reflective account of my participation of the finance course of my program.It identifies the reasons why this theory is relevant to management in today's world and goes on to describe the new things I learnt in this course…

Introduction

In every business, the need to estimate the future cashflow is very important. Businesses have to evaluate the cost of capital and also estimate the future returns that will accrue to the capital when it is invested. In so doing, there is the need for certain forecasting activities to be undertaken to ascertain the future worth of projects and the returns they would yield. From my previous knowledge in finance and economics, I thought the best methods of forecasting and analyzing the cost of capital were the traditional methods like Net Present Value, Internal Rate of Return amongst others.
However, at the earliest stages of studying the Real Options Theory, I realized that those systems are too technical in nature. In other words, they are too specialized and do not take cognizance of important elements of businesses. In my observation of the business environment, I notice that ten years ago, most businesses had finance departments that were often very distinct from the rest of the business. The finance departments specialized in the use of techniques like NPV and the like to forecast and submit reports to the people charged with the management of the business. ...
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