Reel option approach in investment project evaluation

Traditional project evaluation methods interest in achieving one certain result that satisfies investors by taking a picture of a project that contains all related aspects of that project. Most of the results are simple and useful in investors' perspective while the environment is not so steady and predictable. In a world where all future events and decisions are certain, traditional project evaluation methods are able to provide all necessary information to investors. However, if there is uncertainty which needs to be resolved, traditional project evaluation methods need to face some questions. Although these methods seem like taking risks into account, their approach towards risk is quite questionable. On the other hand, while the project is ongoing and uncertainties are being sorted out, the assumption that managers manage the process passively is not a realistic one. Real option approach is dealing with questions which are not addressed by traditional project evaluation methods. In the first chapter of this study, points at which traditional project evaluation methods fail are analysed after defining what the traditional project evaluation methods are. In the second chapter, firstly financial options, which form foundation for real options theoretically, are mentioned so as to understand real options. Also, in this section, there are methods which will also be used in calculating option value- including Black& Scholes. Finally in chapter two, the ways we can use real options in practice and the limits of reel option are analysed. In chapter three, the research and development project of a company which aims to produce electricity by using methane gas is first evaluated with traditional methods and then reevaluated and concluded with real option method. Finally, quantitative results are achieved which demonstrate that real options produce different results than those of other methods. Key Words 1. Real Options 2. Capital Budgeting 3. Project Evaluation 4. Carbon Finance 5. Risk and Managerial Flexibility