OPTIONS THEORY AND STRATEGIC INVESTMENT DECISIONS

This paper discusses use of options pricing theory for evaluating long-term capital investments. Specifically, what is the optimum expenditure level required to create an investment option? Can the Black & Scholes option pricing model be used to determine the approximate option value? This concept may have value to the petroleum industry in western Canada. Many oil companies have made strategic investments that could probably not have been justified by using standard economic analysis. The authors are unaware of any commonly used methodology to evaluate strategic investments. This paper includes a discussion of the variables in the Black & Scholes model to value having the option to develop hypothetical oil sands projects. The analysis will include consideration of the model's limitations and the difficulties of applying it in a corporate setting.