Using real option analysis to manage project risk

Agenbag, André (2003-12)

Thesis (MBA)--Stellenbosch University, 2003.

Thesis

ENGLISH ABSTRACT: This study project aims to use "Real Option Analysis" as a tool to translate financial hedging strategies into business strategies that can be used to hedge business projects against their associated risks. Financial investments are often hedged by means of further investment in financial option structures. These option structures give the investor the option (and sometimes the obligation) to change the constituents of his original investment, depending on changes in the external environment. A well engineered option structure will protect the investor against downside risk, while maximizing profits from upside risk. The objective of this study project is then to adapt some of the standard structures to such an extent that they can be used with similar success in the real business environment. This adaptation is done by means of Real Option Analysis - a relatively new theory whereby business uncertainty and managerial flexibility can be evaluated and quantified in a way similar to financial options. It will be seen that a careful application of Real Option Analysis allows one to take a certain business situation, identify the risks inherent to it, find a suitable option structure to hedge against those risks, and modify this option structure so that it can be implemented as a pure business strategy. This analysis is supported by a detailed derivation of a popular Real Option Analysis model, and an in depth discussion of the differences between Real- and financial options as well as difficulties associated with the implementation of Real Option-based strategies. Several examples of specific business situations are analyzed and it is concluded that Real Option Analysis can provide useful, practical and competitive strategies. Above all, the thought process leading to said strategies is deemed to provide powerful insight into the dynamics of the business/project under evaluation.

AFRIKAANSE OPSOMMING: Hierdie studie projek poog om "Real Option Analysis" te gebruik om finansiele immuniserings strategiee om te skakel in besigheids strategiee wat gebruik kan word om besigheids projekte te beskerm teen hul inherente risikos. Finansiele beleggings word dikwels geimmuniseer deur middel van verdere beleggings in finansiele opsie strukture. Hierdie strukture gee aan die belegger die opsie (en soms die verpligting) om die samestelling van sy oorspronklike belegging aan te pas na gelang van veranderinge in die omgewing. 'n Goed ontwerpte struktuur sal die belegger toelaat om sy winste te maksimeer terwyl verliese as gevolg van negatiewe risiko beperk word. Die doel van die studie projek is dan om sommige van hierdie standaard opsie strukture aan te pas sodat dit nie net in die beleggings wereld nie, maar ook in die besigheids wereld toegepas kan word. Hierdie aanpassing word gedoen met behulp van "Real Option Analysis" - 'n relatief nuwe teorie waarvolgens besigheids onsekerhede and bestuurs aanpasbaarhede geevalueer en gekwantifiseer kan word op 'n soortgelyke wyse as finansiele opsies. Dit sal gesien word dat 'n deeglike toepassing van "Real Option Analysis" die gebruiker toelaat om 'n besigheids situasie te evalueer, die risikos daaran verbonde te identifiseer, 'n toepaslike opsie struktuur te vind wat beskerming sal bied teen hierdie risikos, en dan hierdie struktuur aan te pas sodat dit as 'n besigheid strategie toegepas kan word. Hierdie analise word ondersteun deur die afleiding van 'n populere "Real Option Analysis" model, 'n bespreking van die verskille tussen Rieele- en finansiele opsies, sowel as komplikasies wat verwag kan word tydens die implimentasie van 'n strategie gebasseer op Rieele Opsies. Verskeie voorbeelde van spesifieke besigheids situasies word geanaliseer en dit gee aanleiding tot die gevolgtrekking dat "Real Option Analysis" wel sinvolle, bruikbare en kompeterende strategiee kan voorsien. Verder word daar aangedui dat die denk proses wat lei tot hierdie strategiee, 'n kragtige bron van insig in die besigheid/projek dinamika kan gee.

Please refer to this item in SUNScholar by using the following persistent URL: http://hdl.handle.net/10019.1/53707
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