What are the differences between real options and NPV?

What are the differences between real options and NPV?

Real options and NPV (Net Present Value) are both methods used in investment analysis, but they have different approaches. NPV calculates the value of an investment by discounting future cash flows to present value, while real options consider the flexibility and strategic choices available in investment decisions.

Can you give me an example of how real options might be used?

Sure! For instance, if a company is considering investing in a new technology, a real options approach would allow them to evaluate the option to expand, delay, or abandon the project based on market conditions, rather than just calculating the NPV.

Which method is generally preferred in practice?

It depends on the context. NPV is widely used for its simplicity and straightforwardness, but real options are preferred in uncertain environments where flexibility is valuable.

Are there any limitations to using real options?

Yes, real options can be complex to model and require detailed information about future uncertainties, which may not always be available.