Real Option in Capital Budgeting for SMEs: Insight from Steel Company

摘要

Complex components of investment projects can only be analysed accurately if flexibility and comprehensive consideration of uncertainty are incorporated into valuation. Discounted cash flow (DCF) analysis has failed to cope with strategic future alternatives that affect the right value of investment projects. Real option valuation (ROV) proves to be the right tool for this purpose since it enables to calculate the enlarged or strategic Net Present Value (ENPV). This study attempts to provide an insight of the usage of ROV in capital budgeting and investment decision-making processes of SMEs. Exploring into the first stage processing of steel industry, analysis of alternatives to cancel, to expand, to defer or to abandon is performed. Completed with multiple options interaction and a sensitivity analysis, our findings prove that the application of ROV is beneficial for complex investment projects independently from the size of the company and particularly suitable in scenarios with scarce resources. The application of Real Option Valuation (ROV) is plausible and beneficial for SMEs to be incorporated in the strategic decision making process.