Since the early studies of the 1980s, much has been written about real-option valuation. Led by the seminal work of Brennan and Schwartz,1 who solve for the value of a natural resource investment, these studies sought to build upon the financial-option work of Black and Scholes2 and others. Nevertheless, today there remains a real skepticism among many capital asset valuation professionals as to the role of real-option valuation techniques. The skepticism is driven in part by misconceptions and in part by valid concerns. In this article, I briefly describe the real-option valuation method, discuss the misconceptions and concerns, and take a look at four examples of how the real-option technique can effectively value capital asset projects. The empirical methods are referred to but not explicitly stated.
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