Valuing real options with simulation software

Traditional engineering economic analysis concerns itself mainly with deterministic inputs, even though deterministic data seldom occur in business. Additionally, traditional net present value methods used to evaluate potential projects make no allowance for flexibility by management and assume a static environment. Practitioners often assume that risk analysis and real options are too complicated to include in their analyses. The simplified approach is less accurate and managers often intuitively adjust the results to reflect their understanding of the risks and potential rewards. This paper demonstrates the case that engineering economic analysis with risk analysis and real options can be valued by simulation software that is readily available to owners of personal computers. This novel approach to modeling real options may also encourage more sophisticated and realistic engineering economic analysis.