| BUSINESSWEEK ONLINE : JUNE 7, 1999 ISSUE | ||||||||
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| FINANCE
The New Math in Action Real-options analysis simply says that companies benefit by keeping their options open. Let's say a company is deciding whether to fund a large Internet project that could either make or lose lots of money--most likely lose it. A traditional calculation of net present value, which discounts projected costs and revenues into today's dollars, examines the project as a whole and concludes it's a no-go. But a real-options analysis breaks it into stages and concludes it makes sense to fund at least the first stage. Here's how it works: EVALUATE EACH STAGE OF THE PROJECT SEPARATELY Say the first stage, setting up a Web site, has a net present value of negative $50 million. The second stage, an E-commerce venture to be launched in one year, is tough to value. But let's say the best guess of its net present value is negative $300 million. UNDERSTAND YOUR OPTIONS Setting up the Web site gives you the opportunity--but not the obligation--later to launch the E-commerce venture. In a year, you will know better whether that E-commerce opportunity is worth pursuing. If it's not, all you've lost is the investment in the Web site. However, the second stage could be immensely valuable. REEVALUATE THE PROJECT USING AN OPTIONS MIND-SET In the stock market, formulas such as Black-Scholes calculate how much you should pay for an option to buy, say, IBM at $260 a share by June 30 if its current price is $230. Think of the first stage of your Internet project as buying such an option--risky and out-of-the-money, but cheap. GO FIGURE Taking into account the limited downside of building a Web site and the huge--albeit iffy--opportunities it creates, real-options analysis could give the overall project a present value of, say, $70 million. So the no-go changes to a go. _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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RELATED ITEMS Exploiting Uncertainty TABLE: The New Math in Action TABLE: Who Has Opted for Real Options--And Why Options, Options, Everywhere INTERACT E-Mail to Business Week Online | |||
