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Capital Investment Appraisal - Essay Example
This paper analyzes the role of real options in making strategic investment decisions. Effective capital budgeting is important to corporate survival. During the capital budgeting process, managers make decisions that commit the firm's resources, primarily capital and labour, across business lines and over time…
In applied capital budgeting, however, the fundamental concept of managerial flexibility, or active project management, has been well accepted and long practiced. In the past, one way decision-makers have attempted to supplement a traditional analysis is with "what if" analyses, such as sensitivity analyses, scenario analyses, and simulation. However, richer and more efficient capital budgeting decision-making frameworks are needed; and they should directly translate into increased corporate effectiveness, profitability, and long-term survival in today's globally competitive marketplace. (Black 637-354)
The primary enhanced decision-making framework is a "real option" analysis. During the last fifteen years, increasing attention has been given to the "real option" approach to capital investment decision-making. "Real options ... allow managers to add value to their firm, by acting to amplify good fortune or to mitigate loss". ...