Document Type

Closed Project

Publication Date

Winter 2001


Dragan Milosevic

Course Title

Capstone Project

Course Number

EMGT 589/689


Engineering -- Management, Research and development projects -- Selection, Research and development projects -- Management, Real options (Finance) -- Mathematical models


Firms undertake R&D projects as an investment in the future, yet while selecting the projects, most managers use traditional tools like discounted cash flows to compare and valuate projects without bringing into consideration the possible opportunities that an investment in a certain project can produce. This grossly undervalues some very promising projects. It is no wonder then that many projects get decided on the ‘gut’ feelings of the managers under the premise that they can see ‘promise’ in they project.

Real Options, as a subject, deal with these anomalies in a scientific manner with the intent to ensure that all possible options are analyzed and valuated, giving the opportunity to the decision makers to remain flexible in strategic ways. This is the art of option management. It involves creative hedging and an ability to imagine diverse scenarios. While it carries a strong mathematical touch owing to its roots in finance, it is fairly compatible to other valuation techniques like decision analysis, scenario planning etc. It can best be utilized by managers, however, as discussed in this paper, by combining it with other valuation techniques without getting involved in the financial complexity of option pricing theory.

This paper ana lyzes Real Options as a means to selecting projects. The paper has been written with a view to ensure that the reader does not shy away because of the usage of complex financial theory, which has in fact been one of the sources of real options not being popularly used by decision makers. Yet at the same time it has been ensured that relevant and necessary information on real options is presented to the reader in easy, understandable and sequential manner. If the paper is able to persuade the reader to know more about real options and is made aware of the utility of real options in the field of R&D management, the author would consider it to be his miniscule contribution towards the body of knowledge.


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