The Real Option Approach applied on Foreign Direct Investment Scenarios

The Real Option Approach (ROA) has been put forth as the answer to the problem of valuing manager flexibility and project risk within the framework of capital budgeting. Within this dissertation the ROA is used on one of the riskiest of corporate ventures particularly foreign direct investment. The 1st two problems presented by the author are if the ROA is an interesting approach to capital budgeting with regards to foreign direct investment scenarios and why ROA isn’t commonly used by businesses today. The answer that I have reached from the gathered material is that the Real Option Approach is a precious budgeting method particularly in foreign direct investment scenarios as these contain risk factors that are tough to assess and occur in foreign environments which adversely impact the judgement of managers. The real option approach is superior when compared with older budgeting methods but cultural and political factors have a slowing influence on the adoption of more advanced budgeting techniques and deductively this also has damaging impact on the adoption of the real option approach…

Contents: The Real Option Approach applied on Foreign Direct Investment Scenarios

1.1 Research Question
1.2 Purpose
1.3 Background
2 Method
2.1 Choice of approach
2.2 Literature assessment and validity
2.3 Building a solid case
3 The theoretical setting
3.1 Interpretation of reality through FDI: A continuing development
3.1.1 Definition
3.1.2 Motives behind FDI
3.1.3 FDI – How it is done
3.1.4 FDI and Country Specific Risk
3.1.5 Thoughts about FDI theories
3.2 Discussion about Capital Budgeting Methods
3.2.1 Traditional CB perspective on Risk
3.2.2 Theory Practice Gap
3.2.3 Conclusions drawn from the TCB
3.3 The Real Options Approach
3.3.1 Definition
3.3.2 The Binomial Model
3.3.3 Black & Scholes Option Pricing Model
3.3.4 When should the ROA be used?
3.3.5 Types of Real Options
3.3.6 The methodology suggested when applying ROA
3.3.7 Volatility and risk
3.3.8 Shortcomings of the ROA
3.4 Previous studies of ROA applications on FDI
4 Exemplification
4.1 Basic Scenario
4.2 The Learning Option
1 4.3 The Growth Option
4.4 The Option to Abandon
5 Discussion
6 Conclusion and further studies

Source: Goteborg University

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