In recent years, several authors have developed models that focus on the allocation of scarce marketing resources based on customer lifetime value (CLV). The criterion is particularly useful when NPV lies near zero or uncertainty is large. We discuss examples using this criterion and show its value. When making a decision, a manager only has to observe three parameters: expectation of future cash flow, its uncertainty as measured by its standard deviation, and the magnitude of investment. This new decision index, d, provides a criterion to make investment decisions to capture underlying uncertainty. Using the absolute value of D*, one can make sophisticated decisions considering opportunity losses. Under a lognormal assumption of the distribution of NPV discounted by risk-free rate, we find the "break-even point" at which the NPV equals the real option value (ROV): d = D* = 0.276. A decision-making index d is developed, which is equal to the expectation of net present value (NPV) normalized by its standard deviation.
This paper provides an investment decisionmaking criterion under uncertainty using (deferred) real options methodology to evaluate if an investment should be made immediately, cautiously, deferred (wait-and-watch), or foregone. Uncertainty of market demand, competition, costs and public policy complicates the investment decision process. Investment in infrastructure such as the information and communication technology sector requires large, substantial amounts, most of which are sunk or irreversible. The practical applicability of our model is demonstrated in an illustrative case scenario based on real data.
Our model provides managers with the analytic tool needed to make the business case for CSR initiatives providing an opportunity for firms to create economic, social, and ecological solutions that benefit all stakeholders. Responding to a call for multidisciplinary and multifaceted research in environmental sustainability, this paper integrates ethics, finance, and information technology by viewing investments in environmentally friendly technology as a profit-driven CSR real option. The Bayesian decision framework provides a more flexible approach to investment decision making because it adjusts for new information. We expand on this notion by demonstrating how real option theory, within a Bayesian decision-making framework, can be used by managers to help when making green technology investment decisions. The idea that socially responsible investments can be viewed in terms of real options is relatively new.