The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, Second Edition

Real Options, Risk-Adjusted Value, and Probabilistic Assessments

Before we embark on a discussion of the options to delay, expand, and abandon, it is important that we consider how the real options view of risk differs from how the approaches laid out in the last three chapters look at risk, and the implications of the valuation of risky assets.

When computing the risk-adjusted value for risky assets, we generally discount back the expected cash flows using a discount rate adjusted to reflect risk. We use higher discount rates for riskier assets and thus assign a lower value for any given set of cash flows. In the process, we are faced with the task of converting all possible outcomes in the future into one expected number. The real options ...