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Pape, U./Schmidt-Tank, S. (2004)
Valuing Joint Ventures Using Real Options.
Working Paper Nr. 7, ESCP-EAP Europäische Wirtschaftshochschule Berlin, September 2004.
Chair of Finance
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"Valuing Joint Ventures Using Real Options"
As the valuation of strategic measures becomes increasingly important, relatively few articles have discussed the valuation methods pertained for joint ventures. This paper shows that real options contribute to a better valuation of joint venture projects through superior reflection of the value drivers compared to traditional valuation methodology. Particularly, the strategic value of a joint venture and the value of flexibility that stems from a less than full commitment can be determined using options valuation.
Besides reviewing the basics of real options, the paper discusses the key levers of joint ventures and shows the power of real options in the valuation process. We apply four option types (option to defer, option to expand/acquisition option, option to innovate, and option to abandon) to an imaginary joint venture example and show how to use the Black/Scholes and binomial valuation techniques to value these options. Of the four option types, particularly the option to innovate is important, as it allows to reflect the strategic value of a joint venture generating future business opportunities. Despite its advantages, this valuation methodology also has some drawbacks that are discussed in the concluding section.
Contents
1. Introduction
2. Introduction to real options
2.1 Valuing financial options
2.2 Real options valuation
2.3 Value drivers of real options
3. Joint venture value drivers
3.1 Defining joint ventures
3.2 Value creation through joint venture strategies
3.3 Joint venture value drivers and real options
4. Applying real options to joint ventures
4.1 Assumptions and valuation process
4.2 Confirming the option analogy
4.3 Determining applicable option types
4.4 Building the valuation model and calculating option value
5. Can we use real options then?
6. Conclusions
Pape, Ulrich/Schmidt-Tank, Stephan: Valuing Joint Ventures Using Real Options, Working Paper Nr. 7, ESCP-EAP Europäische Wirtschaftshochschule Berlin, September 2004.
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