The Real Option Approach applied on Foreign Direct Investment Scenarios.

Abstract

The Real Option Approach (ROA) has been put forth as the solution to the problem of valuing manager flexibility and project risk within the framework of capital budgeting. In this thesis the ROA is applied on one of the riskiest of corporate ventures namely foreign direct investment. The first two problems posed by the author are if the ROA is an attractive method of capital budgeting when it comes to foreign direct investment scenarios and why ROA is not widely used by corporations today. The answer that I have reached from the gathered material is that the Real Option Approach is a valuable budgeting method especially in foreign direct investment scenarios since these contain risk factors that are hard to assess and occur in foreign environments that negatively influence the judgement of managers. The real option approach is superior in comparison to older budgeting methods but cultural and political factors have a slowing effect on the adoption of more advanced budgeting techniques and deductively this also has detrimental effect on the adoption of the real option approach. A secondary research problem was to explore if the real option method needs to be modified for each investment scenario and the conclusion of the study is that although the theoretical framework does not need adaptation each type of option situation needs a specific valuation technique and therefore some form of limited adaptation.