Real options Approach to Evaluate a New Investment Projectin Information Technology Infrastructure

摘要

A new trend in corporate planning is to exploit uncertainty by viewing investment opportunities as real options. Thernoptions approach complements the conventional net present value (NPV) criterion for evaluating risky investments.rnIn this paper, we take a broad look at the real options approach to evaluating information technology projects byrnlaying out how it provides an immediate and important perspective on value creation in a world of uncertainty.rnUnlike financial options, real options analysis deals with investments in real assets, a primary interest in engineeringrneconomics.rnThe option valuation methodology permits managers to view two factors, usually considered as disadvantageous inrnan NPV framework, as opportunities to increase the value of investment projects. First, increased volatility does notrntranslate into greater losses because losses are limited to the initial investment. In fact, in an options framework,rngreater volatility implies higher project valuations due to the asymmetric option payoff and the ability to capturernupswings. Secondly, longer decision horizons for an investment project result in higher option values. In the case ofrntraditional NPV approaches, a long time horizon increases the uncertainty of a project, thus lowering its value.rnHowever, using real options, the longer time horizon leads to greater strategic flexibility by allowing newrninformation to update project valuations.rnIt is commonly understood in the real options literature that NPV techniques have a tendency to undervalue assetsrnby excluding the flexibility inherent in the managerial decision-making process. In particular, the discounted cashrnflow (DCF) techniques are not suitable for the evaluation of investment projects in the information technology (IT)rnindustry for several reasons: (1) Most IT infrastructure projects in the telecommunication industry are capitalrnintensive, so any erroneous forecast of product demand can have serious consequences. With any over-expansion,rnunnecessary expenses will have to be paid for unused raw materials and finished products. (2) The major portionsrnof benefits from initial investment projects are usually realized in the subsequent investment outlays. (3) Therncompany could potentially miss out on the future benefits of projects if it does not invest in the current infrastructurernprojects.rnThe DCF approach normally undervalues projects without considering the dynamic nature and strategic flexibility inrnIT infrastructure investments. Conversely, a real options approach attempts to value the strategic flexibility, whilernreferencing the traditional NPV of expected future cash flows. In addition, the options approach allows for a proactive,rncontinuous time decision framework for management.rnThis paper provides a real case study (a leading Korean telecommunication company) of how a real optionsrnapproach addresses many of the issues highlighted above. It evaluates the required investment in the developmentrnof IT infrastructure using a Monte Carlo simulation technique, and verifies the benefits of a real options approachrnfor decision-making.