ABSTRACT

Among the most common problems in corporate strategy are evaluating strategic projects and the timing of follow-up investments in emerging markets. Often strategic projects investment consists of the option to invest in the future growth of the firm. For example, research and development projects, advertising or a pilot plant in the new market may appear to yield a low return when considered in isolation, but generate strategic value from opening up valuable future opportunities (see Myers 1987). This strategic value is likened to options for future company growth. Such strategic projects should not be seen as a one-time investment at the outset, but rather as first links in a chain of interrelated investment projects, providing management the flexibility to alter its planned investment decisions as uncertainty gets resolved over time. Traditional discounted cash flow (DCF) analysis has obvious shortcomings in capturing this flexibility value in sequential investments. Option-based valuation theory, however, provides an analytical tool capable of capturing the interdependence between today’s investment and future investment decisions Baldwin (1982), Brennan and Schwartz (1985), Myers (1987), Trigeorgis (1986), McDonald and Siegel (1986), Majd and Pindyck (1987) and Myers and Majd (1990) provide various examples of investment strategy.