grad-real-options

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SKILL.md

Real Options

Overview

Real options theory applies financial option pricing logic to corporate investment decisions. It recognizes that managers can adapt their decisions as uncertainty resolves — deferring, expanding, contracting, or abandoning projects. Traditional NPV, which assumes a now-or-never commitment, systematically undervalues projects with significant flexibility.

When to Use

  • Evaluating investments with high uncertainty and managerial flexibility
  • Comparing staged vs. committed investment strategies
  • Valuing natural resource extraction, R&D, or platform investments
  • When NPV is near zero but the project has strategic optionality

When NOT to Use

  • For routine, low-uncertainty investments where NPV suffices
  • When flexibility is contractually or practically absent
  • If the option exercise conditions are unclear or unquantifiable
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