Real Options Evaluation of Financial Investment in Flexible Manufacturing Systems in the Automotive Industry

Abstract

Applying financial option pricing theory to real world investment evaluation practice, real option analysis is quickly emerging as a new approach to economic evaluation and selection of strategic investment alternatives in non-financial industries.

The objective of this research is to apply real options theory to evaluate financial investments in flexible manufacturing systems in the automotive industry and help to identify future growth opportunities both in national and international markets. Models were developed to capture the strategic value of management and operational flexibility for capital investments in a flexible manufacturing system.

Financial option pricing models were reviewed with the analogy between financial option pricing and real option analysis discussed in order to establish the real options analysis framework. An evaluation model was also developed to account for foreign exchange risk for financial investments in foreign countries. Real options analysis was applied to evaluate investments in flexible manufacturing systems in the automotive industry for both the economy of scope and the economy of scale. Advantages and concerns related to the application of real options analysis are discussed with brief comments on future research needs.