Real Option Analysis: The Profession's Next Cutting-Edge Tool

Kautt, Glenn
February 2003
Journal of Financial Planning;Feb2003, Vol. 16 Issue 2, p72
Academic Journal
The article explores the real option analysis as a cutting-edge financial planning tool. With the advent of stochastic financial planning models, planners now have tools to help forecast the probability of certain outcomes. Yet, many important decisions cannot be made using the available forecasting tools. A type of planning tool is being developed to analyze information for these types of decisions, it employs a methodology called real option analysis, which provides a framework for making informed decisions about problems that could not be readily solved in the past. In a similar fashion, when developing comprehensive financial plans for clients, planners may wish to employ certain analytical tools and processes and not others, based on their skills and the specific needs and objectives of each client. Sometimes planners needs the most advanced analytical tools to provide counsel for clients and sometimes no analytical tools are necessary. A discounted cash flow model is built, using assumptions that approach the conditions of the situation but do not take into account the uncertainty of the future. Because the deterministic net present value model produces only one umber, there is usually little or no confidence in its accuracy.


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