The application of real options as an enhancement to the net present value technique : a case of the financial services sector

Abstract

There has been an incredible transformation in the capital budgeting literature over the past fifty years. Traditional methods, such as Net Present Value (NPV), are at best arbitrary decision-making tools, causing many uncertainties throughout the project lifespan. A major concern is that traditional investment models such as NPV do not adequately evaluate investments under uncertainty, so they cannot integrate managerial flexibility into decision-making. On the other hand, real option analysis draws on the traditional NPV technique and creates a broader range of investment alternatives, allowing management to effectively account for these uncertainties. This study examined the perceptions of financial planners on the application of real options as an enhancement to the NPV technique in the Durban financial services sector. This study focused on a quantitative research design and used questionnaires to gather primary data. The target population of this study was 286 certified financial planners from Durban, KwaZulu-Natal. Data analysis comprised both descriptive and inferential statistics, allowing the researcher to draw conclusions about the target population and suggesting ideas for future research. The results of this study concluded that NPV is insufficient as a standalone capital budgeting technique and that the usage of real options within the NPV framework enhances decision-making in investments when uncertainty is present. The results of the study also indicated that some of the financial planners who participated were unfamiliar with or had limited knowledge of real options, which prevented them from applying these judiciously. It is therefore recommended that these participants enrol in a professional development program on this subject to increase their knowledge and competence in dealing with real options appropriately in financial and investment decision-making. The study used certified financial planners from Durban's central business district, who are part of the country's financial services sector. To make the results generalisable in the context of South Africa, future studies should explore the same topic using certified financial planners from other cities.