Using the WACC to Value Real Options

摘要

Use of the weighted-average cost of capital (WACC) in real-option valuation is an alternative to using risk-neutral real-option valuation. Using the WACC involves a marginal increase in mathematical complexity, but the method is easy to implement in a spreadsheet and easy to present to company managers, clients, and colleagues. Because real-option valuation is immune to choices of admissible discount rates, however, the critical issue is correct estimation of volatility, not choice of discount rate. We also point out that the natural and conservative tendency to overestimate risk is anything but conservative in a real-option valuation.