Real Options and Rules of Thumb in Capital Budgeting
نویسندگان
چکیده
Most firms do not make explicit use of real option techniques in evaluating investments. Nevertheless, real option considerations can be a significant component of value, and firms which approximately take them into account should outperform firms which do not. This paper asks whether the use of seemingly arbitrary investment criteria, such as hurdle rates and profitability indexes, can proxy for the use of more sophisticated real options valuation. We find that for a variety of parameters, particular hurdle-rate and profitability index rules can provide close-to-optimal investment decisions. Thus, it may be that firms using seemingly arbitrary “rules of thumb” are approximating optimal decisions. For helpful comments I thank Jonathan Berk, Michael Brennan, Debbie Lucas, Lenos Trigeorgis, and seminar participants at Northwestern University, the Federal Reserve Bank of New York, and the conference “Real Options: Theory Meets Practice”, held at Columbia University in June 1997. Real Options and Rules of Thumb in Capital Budgeting
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