PRACTICABILITY OF BINOMIAL APPROACH IMPLEMENTATION WITHIN METHOD OF REAL OPTION VALUATION

Abstract

The subject of current research is implication of real option valuation method (ROV) & its usefulness within project evaluation. The attention is paid to investment projects with high level of risk & uncertainty. Comparing aforementioned method with traditional approaches, one can conclude that ROV includes plenty of advantages among which is management flexibility, which serves to control the process of project implementation at each step & helps investors to arrive at the decision whether to continue or abandon the project on its initial stage. Also, ROV allows the application of risk-free rate in DCF model, which significantly increases the terminal value of the project. This becomes possible because ROV considerably decreases the level of risks associated with implementation process, such as uncertainty in choosing the right moment to enter the project & possibility of bearing substantial costs. Results of our research include classification table of real options, substantiation of using risk-free rate in DCF model within ROV method & comparative characteristics of ROV vs traditional approaches. Moreover, we considered limitations of Binomial & Black — Scholes models & proved the practicability of using the Binomial approach (by the example of option to abandon).