Managerial Flexibility Using ROV
A Survey of the Top 40 JSE Listed Companies
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The traditional DCF techniques have been criticised of late due to the rigidity of their criteria when making capital budgeting decisions. Real Option Valuation (ROV) is suggested as an alternative because it implicitly incorporates flexibility in project valuation. With ROV, opportunities in projects are treated as real options and are therefore valued using financial option principles. Real Options give the firm the opportunity to act on an investment project (invest, abandon, rescale) at a later date, when more information is available. The primary aim of this study is to determine through ...
The traditional DCF techniques have been criticised of late due to the rigidity of their criteria when making capital budgeting decisions. Real Option Valuation (ROV) is suggested as an alternative because it implicitly incorporates flexibility in project valuation. With ROV, opportunities in projects are treated as real options and are therefore valued using financial option principles. Real Options give the firm the opportunity to act on an investment project (invest, abandon, rescale) at a later date, when more information is available. The primary aim of this study is to determine through a survey, whether companies tracked by the JSE/FTSE Top 40 index in South Africa, are using ROV. Despite the endorsement of the technique by academics, only a few firms seem to have adopted it. Just nine percent of the respondents claimed to be using the technique. This is largely attributed to managers being unaware of the technique, and to some extent, the complexity of employing it in practice. On the other hand, managers were generally found to recognise the flexibility in their projects despite not using ROV, although it was not confirmed whether and how they quantify this flexibility.
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