Bruno Miller and John-Paul Clarke

1. Abstract Investment decisions in new aircraft development programs are difficult because of large capital expenditures, long lead times, and many technical and market uncertainties. A flexible strategy that takes advantage of the ability of managers to incorporate information as uncertainties are resolved is suggested as a means to manage risk. In this paper, the use of real options analysis to evaluate and guide new aircraft development programs is illustrated through a case study of a real-world aircraft program. The analysis provides clear evidence that investors can use the numerical results of the real options analysis to determine how much they should spend on an aircraft program, that managers can use the same results to restructure the program to improve the financial feasibility of the project, and that both investors and managers can use the output of derivative analyses to define minimum requirements (in terms of aircraft orders) to ensure program success. The analysis is based on a generalized real options methodology in which the value of completion and the strategy-enabling completion cost (commonly referred to as stock price and strike price in the real options literature, respectively) may be described by any probability distribution. Thus, with this methodology, it is not necessary to force the representation of the value of completion into known stochastic processes, such as the commonly-used geometric Brownian motion, or to assume that the cost of completion is fixed a-priori.