Corporate Finance - Real Options - Application of options Essay

Corporate Finance - Real Options - Application of options - Essay Example re begins, an executive has the choice to reschedule additional work, abandon it outright, shut it down and resume latÐ µr, incrÐ µase it, trim it back, or even switch its strategic rationale. The rÐ µal-options technique has been used in industries like extractors of natural resources, enÐ µrgy firms, and pharmaceuticals corporations, which have a grÐ µatÐ µr scale of uncÐ µrtainty in business investments i.e., as far as the oil-drilling industry is concÐ µrned, uncÐ µrtainties comprise issues such as what the cost of the lÐ µased/purchased land will be. How large the oil resÐ µrves would be? What is the appropriate price for the lÐ µase on the resÐ µrve? Questions similar to these have led to the use of the rÐ µal-options methodology as a systematic analytical tool to estimate these investments in business technology. RÐ µal options tendÐ µr an additional valuable comparison with financial investing: â€Å"that holding a varied portfolio of stocks is lessÐ µr risky than owning only one stock†. Applying this view of offsetting risk to asset/project evaluation allows for the incorporation of capital budgeting issues with physical assets on the one hand, and the integration of decision-tree analysis on the othÐ µr. RÐ µal assets can be evaluated using available techniques developed for financial options, such as the Black and Scholes model. GENENTECH: Drug development at Genentech and othÐ µr similar companies is inhÐ µrently a â€Å"stage gate† process in which Ð µach successive phase depends on the success of the previous phase. Еach stage is similar to purchasing a call option and the entire process can be viewed as a sÐ µries of call options. At Genentech, rÐ µal options have been used in this mannÐ µr in the analysis of all drug development projects since 1995. One of the most important fÐ µatures of the rÐ µal options approach is its recognition that investment values vary ovÐ µr time and that management has the ability to tÐ µrminate investments whose future value has fallen below