The timing of capital investments is a vital decision faced by a firm's managers. Traditional discounted cash flow valuation methods are limited to situations in which investment is “now or never”. Real options models have been developed to overcome these limitations, allowing analysts to incorporate flexibility in their capital spending decisions. Unlike financial options, exercise of a real option by one firm may directly affect the value of that same option to a competing firm. Strategic interactions present significant challenges that may render classical models inadequate to the task of managing firm's capital investments. This chapter describes and summarizes the framework and the solution to the classical real options model as well as its integration with competition when the flexibility is limited to timing of investments.
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