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1、P1: OTA/XYZP2: ABC c32JWBT347/MckinseyJune 9, 201011:45Printer Name: Hamilton32Valuing FlexibilityIn valuing companies with the standard discounted cash flow (DCF) ap- proaches outlined in Part Two, we did not consider the value of managerialflexibility. Managers react to changes in the economic env
2、ironment by adjust- ing their plans and strategies. For example, they may choose to scale back or abandon an investment project that delivers poor results, or to expand orextend the project if it is highly successful. Such flexible changes of plan can take many different forms, and each may have a s
3、ubstantial impact on value.A standard DCF approach based on a single cash flow projection, or evenmultiple cash flow scenarios, cannot calculate what that impact is.Managerialflexibilityisnotthesameasuncertainty.Companiesorprojects with highly uncertain futures involving a single management decision
4、, such as business start-ups with high growth potential, can indeed be valued using a standard DCF approach under different scenarios (see, for example, Chapter 34). Flexibility refers to choices between alternative plans that managers may make in response to events. For example, if they have planne
5、d to stage their investments in the business start-up, they may decide whether to proceed or not at each stage, depending on information arising from the stage before. Forcases where managers expect to respond flexibly to events, we need a special, contingent valuation approach.Company-wide valuatio
6、n models rarely take flexibility into account. Toanalyze and model flexibility accurately, you must be able to describe the setof specific decisions managers could make in response to future events, andinclude the cash flow implications of those decisions. In valuing a company,flexibility therefore
7、becomes relevant only in cases where management re-sponses to specific events may change the course of the whole company. For example, to value Internet or biotech companies with a handful of promisingnew products in development, you could project sales, profit, and investments for the company as a
8、whole that are conditional on the success of product679P1: OTA/XYZP2: ABC c32JWBT347/MckinseyJune 9, 201011:45Printer Name: Hamilton680VALUING FLEXIBILITYdevelopment.1Anotherexampleisacompanythathasbuiltitsstrategyaround buying up smaller players and integrating them into a bigger entity, captur-ing
9、 synergies along the way. The first acquisitions may not create value in their own right but may open opportunities for value creation through further acquisitions. Flexibility is typically more relevant in the valuation of individual busi- nesses and projects, as it mostly concerns detailed decisio
10、ns related to produc- tion, capacity investment, marketing, research and development, and so on. Inthis chapter, we concentrate on how to value flexibility when valuing projects. We explore two contingent valuation approaches: real-option valuation (ROV), based on formal option-pricing models, and d
11、ecision tree analysis (DTA). Although they differ on some technical points, both boil down to fore-casting, implicitly or explicitly, the future free cash flows contingent on the future states of the world and management decisions, and then discounting these to todays value. You should learn both th
12、e ROV and the DTA approaches, because eachhas advantages depending on the types of risks involved. Valuing flexibility does not always require sophisticated, formal option-pricing models. The DTAapproach is an effective alternative for valuing flexibility related to, for ex- ample, technological ris
13、k but not commodity risk. Furthermore, if you haveno reliable estimates on the value and variance of the cash flows underlyingthe investment decision, there is little justification for using sophisticated ROV approaches. In addition, the DTA approach is more transparent to managers than is ROV, whic
14、h most managers cannot easily decipher. Real-optionvaluationistheoreticallysuperiortoDTA,butitisnottherightapproach in every case. By definition, it cannot replace traditional discountedcash flow, because valuing an option using ROV still depends on knowing the value of the underlying assets. Unless
15、 the assets have an observable market price, you will have to estimate that value using traditional DCF. Because commodity prices are observable, the ROV approach is especially well suited to decisions in commodity-based businesses, such as investments in oil andgas fields, refining facilities, chem
16、ical plants, and power generators.2Thischapterislimitedtothebasicconceptsofvaluingmanagerialflexibility and real options. We focus on the following topics:rFundamental concepts behind uncertainty, flexibility, and value (whenand why flexibility has value)1See, for example, E. S. Schwartz and M. Moon, “Rational Pricing of Internet Companies,” FinancialAnalysts Journal 56, no. 3 (2000): 6275; and D. Kellog and J. Charnes, “Real-Options Valuation for a Biotechnology Company,” Financial Analysts J
