An opportunity cost model to value deferral options

Abstract

This study discusses a real options valuation approach based on the familiar opportunity cost concept. After demonstrating the equivalence of the opportunity model to the binomial lattice approach of Cox, Ross, and Rubinstein (CRR), we discuss its attributes through simple numerical examples. In contrast to the CRR approach, the transparency of the opportunity model provides an intuitive and economical baseline for managerial discussions and decision-making. We focus on the opportunity costs inherently embedded in the real options value (ROV); therefore, our study is distinct from most other studies, which consider them as the exogenous input to the ROV.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 This interest rate was quoted as of July 12, 2010, http://www.bankrate.com/rates/interest-rates/1-year-treasury-rate.aspx.

2 This interest rate was quoted as of July 12, 2010, http://www.bankrate.com/rates/interest-rates/1-year-treasury-rate.aspx.

Additional information

Funding

Jung Woo Baek was supported by a National Research Foundation of Korea (NRF) grant funded by the Korean government (MSIT) (No. 2021R1A2C1011207).

Notes on contributors

Gyutai Kim

Gyutai Kim received his BS in Industrial Engineering from Sung Kyun Kwan University, his MS in Industrial Engineering from Fairleigh Dickinson University, and his Ph. D in Industrial & Systems Engineering in Auburn University. He is currently a full professor in the Department of Industrial Engineering at Chosun University in Korea. His research interests are an economic analysis of real investment projects and an application of real options valuing theory.

Luke Miller

Luke Miller received his BS in Systems Engineering from the University of Virginia; and his MS and PhD in Industrial & Systems Engineering from Auburn University. He is currently a finance professor at Saint Anselm College in New Hampshire, USA. Luke’s research has been presented and published all over the world, and he most recently won Best Presentation Award at the 18th International Conference on Business & Finance in Paris. Further, he offers consulting services to over two dozen Fortune 500 companies regularly discussing strategies with top executives. In 2003, Luke earned the Gilbreth Memorial Fellowship and has since published dozens of peer-reviewed journal articles and a book on the topic of real options.

Jung Woo Baek

Jung Woo Baek received his B.S., M.S., and Ph.D. degrees in Industrial Engineering from Sungkyunkwan University (Suwon, South Korea) in 2003, 2005, and 2010. He currently is an Associate Professor in the Department of Industrial and Systems Engineering in Dongguk University (Seoul, South Korea). His research interests are operations research, stochastic process, queueing theory, and, inventory control.