Real Options from BUS 207 at Korea University. Real Option / Strategic Decision Trees Analysis Compiled by Ted Fu July 1, 2002 Adapted from Luenberger: Investment Science Smith: Entrepreneurial Finance Click: International Financial Management Opportunities to alter input and output prices fluctuate with exchange rate changes. View Notes - 3. This technique is based on mapping all the available options on a given project and incorporating market uncertainties. T raditional decision analysis methods can provide an intuitive approach to valuing projects with managerial flexibility or real options. 1 Real options Decision trees : discrete number of possibilities Application of financial options to real options : continuous number of Trees to Solve Real-Option Valuation Problems, Decision Analysis, v2, 69-88. They use the risk-neutral probabilities from the option pricing model in the decision tree to solve for the option’s value. The authors present an approach that combines real options theory with decision tree analysis to properly evaluate a project facing uncertainties. Moreover, these two approaches require the estimation of the standard deviation sigma, of continuously compounded annualized return from the project. 6 (because of legal restrictions or other barriers to entry to competitors), however, the The use of these two approaches for evaluation of real assets is somewhat complex and difficult to understand.

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