Real Options Theory in the Term Paper

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Different theorists and proponents of real options theory identify different specifics of the theories operation, but in one widely held view there are five real options: the waiting-to-invest option, the growth option, the flexibility option, the exit option and the learning option (Wade 2005). Each one of these options takes in a different value given other environmental and internal considerations, and from the plotted valuations of these real options more effective and secure strategic decisions can be made (Reuer & Tong 2007; Wade 2005).

Real World Application

The fact that the primary focus on the real options theory and model has been academic in nature rather than practical and direct in its application does not mean that real world inferences cannot be drawn from the work that has been conducted and the research that has been published. The degree to which the model created by the real options theory fits real world data and situations is one of the major reasons that this theory has garnered so much interest, and thus even applications and uses of this theoretical framework that remain academic and entirely theoretical can be used to demonstrate the practical usefulness of this theory. Predictions and calculations regarding the real world can be made on an academic basis and still be measured in the real world even without having real and concrete effects, and this is exactly what many academic studies of this theory have accomplished.

In a 2002 study, two researchers demonstrated that using several distinct real options models could provide accurate and successful strategic decisions regarding it investments (Li & Johnson 2002). Essentially, these researchers were able to demonstrate -- first by modeling and then by measuring real world scenarios and organizations -- that the real options theory was accurate in its predictive capabilities so long as enough environmental information was present to derive accurate valuations for various decisions (Li & Johnson 2002).

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The real options theory always depends on the careful gathering an analysis of comprehensive information, and like all models is only as good as the information fed into it.

To this end, these researchers also developed specific sets of variables that needed to be accounted for when making it investment decisions specifically, ultimately developing four different categories into which they divided it investment opportunities (Li & Johnson 2002). The criteria by which opportunities were divided into these categories were the switching costs and the nature of the competition that existed in the investment opportunity and environment, with the combinations of low or high switching costs paired with shared or proprietary opportunities comprising the four different categories (Li Johnson 2002). The valuation of the various real options that exist for investment opportunities in each of these four categories changes depending on the circumstances of that category (Li & Johnson 2002). The categories and circumstances in other scenarios would be entirely different than those utilized by these researchers, but they were able to show quite clearly that as long as accurate and relevant information is used to create a real options theory model, it can be quite successful in predicting outcomes and suggesting finance decisions (Li & Johnson 2002).

Conclusion

There is a great deal of investigation into the real options theory and its interplay in the real world that would be of great use to academics and finance decision makers alike. Increasing awareness and utilization of this theoretical framework will likely lead to the necessary research and investigation in the coming years. It will also lead to many more successful business decisions if properly employed by today's organizations......

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