In this diploma seminar work, I will introduce the concept of real options into capital planning. Using option valuation theory, I will extend the basic discounted cash flow (DCF) method, which is commonly used to evaluate capital projects, and highlight some of its limitations. Through the Wiener process and Itô stochastic calculus, I will derive the Black–Scholes model for option valuation. I will also derive Margrabe’s formula. Furthermore, I will qualitatively analyze capital projects within the real option space. Real options will also be illustrated with an interesting real-world example. In the conclusion, I will point out the limitations of the derived model for valuing real options.
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