Real options analysis in advanced manufacturing technologies

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Abstract
Manufacturing companies are confronted with rapid developments of computer-aided technologies as well as substantial changes in market and economic conditions. Investments in advanced manufacturing technologies (AMT) are, therefore, highly forward-looking. On the one hand the possibilities of later integration of constituent projects must be considered, on the other hand fluctuating market conditions have to be taken into account. An incremental approach toward the introduction of AMT offers more flexibility within the decisionmaking process, but the value of this managerial flexibility is difficult to measure. Traditional discounted cashflow techniques for the economic evaluation of investments cannot properly reckon with the opportunity of conditional investment making dependent on future market developments. Option analysis provides an answer to this issue by creating an analogy between the valuation of options on shares and serial investment planning. In this paper, option analysis is applied to investments in AMT, using actual project data. Based on traditional criteria, it is questionable whether the management should invest in AMT. As demonstrated by the paper, however, the first step in the investment process can be framed and valued as buying an option on the total conversion of the existing manufacturing process, whereas the attractiveness of this option is related to the volatility of the market segments in which the company operates. The calculated option value indicates that the opportunity to integrate the first project at a later stage with follow-up investments well exceeds the negative net present value of the project as a stand-alone island of automation.

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