A Pragmatic Guide to Real Options

A Pragmatic Guide to Real Options fills the gap for an introductory guide to building intuition and realizing the benefits of real options models. The goal is to take the reader through the math and the logic of option pricing in a very deliberate manner and to demonstrate how option pricing techniques can then be applied to corporate decision-making.

Author Tom Arnold demonstrates how NPV analysis is very static because it uses what appear to be very deterministic future cash flows. He engagingly introduces all mathematical and financial elements in a very clear manner and presents binomial trees for forecasting project cash flows. The cash flow binomial tree is then adapted to become an NPV-embedded binomial tree upon which real option analysis is performed. The real option analyses are performed using risk-adjusted pricing with certainty equivalence and risk-neutral pricing.

The techniques introduced in the text retain much of the familiar NPV analysis, but within a more dynamic environment. Further, Arnold also helps readers visualize how possible future actions create more value for a project and what types of actions could be considered to generate more value.