The Real Option Approach applied on Foreign Direct Investment Scenarios

The Real Option Approach (ROA) has been put forward as the means to fix the issue of valuing manager flexibility and project risk within the framework of capital budgeting. Within this project the ROA is used on one of the riskiest of corporate ventures specifically foreign direct investment. The initial 2 problems presented by the author are if the ROA is an appealing approach to capital budgeting with regards to foreign direct investment scenarios and why ROA isn’t commonly used by corporations today. The solution that I have reached from the collected material is that the Real Option Approach is actually a beneficial budgeting method particularly in foreign direct investment scenarios as these include risk factors that are tough to evaluate and occur in foreign environments which adversely impact the judgement of managers. The real option approach is outstanding compared to older budgeting techniques but cultural and political factors have a slowing impact on the adoption of more advanced budgeting methods and deductively this also has damaging impact on the adoption of the real option approach…

Contents: Real Option Approach applied on Foreign Direct Investment Scenarios

1.1 Research Question
1.2 Purpose
1.3 Background
2 Method
2.1 Choice of approach
2.2 Literature assessment and validity
2.3 Building a solid case
3 The theoretical setting
3.1 Interpretation of reality through FDI: A continuing development
3.1.1 Definition
3.1.2 Motives behind FDI
3.1.3 FDI – How it is done
3.1.4 FDI and Country Specific Risk
3.1.5 Thoughts about FDI theories
3.2 Discussion about Capital Budgeting Methods
3.2.1 Traditional CB perspective on Risk
3.2.2 Theory Practice Gap
3.2.3 Conclusions drawn from the TCB
3.3 The Real Options Approach
3.3.1 Definition
3.3.2 The Binomial Model
3.3.3 Black & Scholes Option Pricing Model
3.3.4 When should the ROA be used?
3.3.5 Types of Real Options
3.3.6 The methodology suggested when applying ROA
3.3.7 Volatility and risk
3.3.8 Shortcomings of the ROA
3.4 Previous studies of ROA applications on FDI
4 Exemplification
4.1 Basic Scenario
4.2 The Learning Option
1 4.3 The Growth Option
4.4 The Option to Abandon
5 Discussion…

Source: Goteborg University

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