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Tutorial CIFER-T2 Boeing's method for valuing high-risk high-return technology projects using real options

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1 Author(s)
Mathews, Scott H. ; Boeing Research & Technology, The Boeing Company, Seattle, WA, USA

Technologists and engineers endeavor to design and propose leading edge concepts, but the development of these concepts ultimately depends on obtaining funds justified by a business case. This tutorial provides technologists with the business-case methods and tools to calculate the value of projects involving risky new technology or markets but potentially offer higher returns in the long run. These straightforward methods and tools have been adopted from sophisticated techniques used in the options markets, where investments in risky securities are routinely traded. We first present an example scenario for a new product and review a typical business case using net present value analysis. Next we develop a “what-if” multi-scenario business case model using Monte Carlo simulation. An introduction to real options is then provided. A real option, an option investment in “real” physical assets such as a technology or project, is based on the same concept as financial options. Finally, we determine a risk-averse investment decision using real options calculated with an intuitive and transparent algorithmic tool. Two classic option-value techniques are introduced: the Nobel Prize winning Black-Scholes formula and a graphical approach called the binomial lattice model. Finally, we introduce a new real option value algorithm, the Datar-Mathews Method that is both intuitive and transparent. In conclusion we show Business Engineering is a new approach that provides engineers with investment and risk modeling tools and methods that can be incorporated alongside standard systems engineering design modeling techniques to justify the targeting of project investment dollars to manage risk, shape value outcomes, and make better strategic decisions.

Published in:

Computational Intelligence for Financial Engineering, 2009. CIFEr '09. IEEE Symposium on

Date of Conference:

March 30 2009-April 2 2009