it may still be a good project if the firm waits. Defining PVCF again as the
present value of the cash flows, the firm’s decision rule to accept the project
should be if PVCF > C. If the firm does not take on the project, it incurs no
additional cash flows, though it will lose what it originally invested in the
project. The price of the project, such as an R&D project, is the price of
the call option. The exercise price of the call option is the cost of future in-
vestments needed when an initial investment is made. The project expected
net present value is analogous to the price of stock in the Black-Scholes op-
tion pricing model formulation. The underlying asset is the project, the
strike price of the option is the investment needed to take the project, and
the life of the option is the period for which the firm has rights to the proj-
ect. The variance in this present value represents the variance of the under-
lying asset. The value of the option is largely derived from the variance in
cash flows, as the higher the variance, the higher the value of the project
delay option. Thus, the value of an option to do a project in a stable busi-
ness will be less than the value of one in a changing environment. Mitchell
and Hamilton (1988) emphasize that management needs to identify strate-
gic objectives, review the impact of strategic options such as R&D projects
directed toward strategic planning, and identify the strategic planning tar-
gets of future R&D projects.
Implications of Viewing the Right to Delay a Project
as an Option
Several interesting implications emerge from the analysis of the option to
delay a project as an option. First, a project may have a negative net pres-
ent value based on expected cash flows currently, but it may still be a valu-
able project because of the option characteristics. Thus, while a negative
net present value should encourage a firm to reject a project, it should not
lead it to conclude that the rights to this project are worthless. Second, a
project may have a positive net present value but still not be accepted right
away. This is because the firm may gain by waiting and accepting the proj-
ect in a future period, particularly for risky projects. In static analysis, in-
creasing uncertainty increases the riskiness of the project and may make it
less attractive. When the project is viewed as an option, an increase in the
uncertainty may actually make the option more valuable, not less.