Real Options Analysis

ROA (not to be confused with return on assets) applies put option and call option valuation techniques to capital budgeting decisions. A real option itself, is the right — but not the obligation — to undertake some business decision; typically the option to make, abandon, expand, or shrink a capital investment.

"The opportunity to invest in the expansion of a firm's factory, or alternatively to sell the factory, is a real option."

ROA, as a discipline, extends from its application in Corporate Finance, to decision making under uncertainty in general, adapting the mathematical techniques developed for financial options to "real-life" decisions. For example, R&D managers can use Real Options Analysis to help them determine where to best invest their money in research; a non business example might be the decision to join the work force, or rather, to forgo several years of income and to attend graduate school. Thus, in that it forces decision makers to be explicit about the assumptions underlying their projections, ROA is increasingly employed as a tool in business strategy formulation.