Real Options: an Application to RMS Investment Evaluation
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Market globalization and aggressive economic competition are driving a trend in manufacturing toward the adoption of flexibility features in order to better react to changes related to customer needs, process technologies, government directives, etc. Wide-ranging research efforts have been carried out in order to understand which of these flexibility features are critical in achieving the particular business tasks and how or when to implement them. Flexibility can be purchased through special features in capital equipment, and it can take a form of flexible manufacturing equipment, options to change the product mix, and the opportunity to temporarily shut down and restart production systems. Flexibility also includes options to switch production across various plant locations, depending on labor conditions, demand and currency fluctuations. Therefore, flexibility allows the management to take advantage of the outcomes better than expected and at the same time to reduce the losses. This capability must add a value to the investment project having such embedded options. (Bengtsson 2001).
KeywordsPayoff Function Real Option Product Family Demand Forecast Geometric Brownian Motion
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