Question

How do real options affect the value of capital projects?

Answer 1

Real options focus on tangible assets rather than financial instruments and involve choices to expand or restrict projects based on various conditions. Factoring in real options affect the value of capital projects since it allows estimation of opportunity cost of continuing or abandoning a certain project. For instance setting up a new machine may provide real choices of introducing new products which should be considered when the capital project is being analysed based upon estimations of their probabilities. So real options allow analysis of the project based on real choices.