Real OptionsAn Exploration into the Development, Application, and Further Growth of

Real Options Analysis

Manage Risk While Lowering Costs and Increasing Profits

Research Members

COLLEGE OF BUSINESS

Whitley Poyser -- Department of Marketing and Logistics, Honors CollegeAlan Davis -- Department of Finance, Insurance, Real Estate, and Law Danon Gentry -- Information Technology and Decision Sciences Miguel Robinson -- Department of Accounting

FACULTY MENTORSIla Manuj, Terrance Pohlen, and Ted Farris Department of Marketing and Logistics

Agenda

• Research Question and Objectives• Areas explored• Findings: Common items, difference in

approaches, issues• Recommendations• Learning from the project

Why We Researched?

• Lack of application in Logistics and Supply chain environment

• Research Question:– Can a Real Options approach be utilized in a

Logistics and Supply chain environment?

What is an option?An option gives the buyer the right but not the obligation to

purchase an asset in the future at a predetermined price.

(Janney, J. J., & Dess, G. G. 1993)_____________________________________________________________________________________-

Real Options Analysis expands options theory to include real assets and working

decisions(Amram, M., & Kulatilaka, N.  1999)

Areas of Research

• Finance• Real Estate• Accounting• Operations Management

Finance

• History– Developed in the 1970’s (Brennan, M. J., & Trigeorgis, L. 2003)

– Black-Scholes Model (Brennan, M. J., & Trigeorgis, L. 2003)

– Binomial Models (Amram, M., & Kulatilaka, N. 1999)

– Real Options Analysis (ROA) is included in numerous MBA programs

Finance

• Opportunities– Identifies a greater number of value-adding

opportunities– Increases flexibility– Ability to mitigate losses

Real Estate

• History– Limited research (Bulan, Mayer, Somerville 2008)

– Most research has centered on valuation, development, and lease options (Grenadier 1995 and Kenyon and Tompaidis 2001)

Real Estate

• Opportunities (Bulan, Mayer, Somerville 2008)

– Allows real estate investments to be reversible.

– Ability to lock future development at optimum prices.

– Allows for contingency planning

Accounting

• Financial Accounting Standard for real options (Conover, Chen, Kensinger 2005)

• “Satisfactory disclosure requires that accounting reports include adequate information about the firm’s real options” (Conover, Chen, Kensinger 2005)

• Conservative accounting vs. aggressive accounting (Conover, Chen, Kensinger 2005)

Accounting

• Guidelines on how to record real option transactions

• Research– How to account for different types of real options

Operations Management

• Real options allow management to make decision to move forward with potential projects, delay, or abandon them. (Janney, J. J., & Dess, G. G. 1993)

• “Managerial adventurism” is one reason ROA has not been fully integrated into management decisions . (Janney, J. J., & Dess, G. G. 1993)

Operations Management

• Companies that have used this method have used it to apply one specific decision rather than many decisions of the same caliber– Corporate Social Responsibility (Husted 2005)

– Joint Ventures (van Putten, A. B., & MacMillan 2004)

Findings

• Not a widely accepted/used method of valuation

• All areas explored documented use and benefits of ROA

• Lack of application due to:– Complicated valuation process– Unwillingness to halt/terminate a project– Segregation between business units– Non-existence of disclosure requirements

Recommendations

• Training– Educate executives and managers about ROA

• Encouragement– Provide incentives for managers who effectively

use ROA

• Research– Further research to facilitate ROA’s move from

the academic world into the business world

Learning

• Some of the learning experiences we can take from this research:– Group work– Database searching– Article Analysis– Faculty Mentorship – Research Preparation and Writing