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Extended MAD for Real Option Valuation A Case Study of Abandonment Option

This paper extends the marketed asset disclaimer approach for real option valuation. In sharp contrast to the dominant real option valuation that assumes a stochastic process for an investment’s capital value, this paper demonstrates the valuation of a real option assuming that cash flow follows a stochastic process. We show that this method is at least equally effective and sometimes more intuitive. We note that, in a discounted cash flow (DCF) framework, certain constraints must be met, and assuming capital value as a geometric Brownian motion (GBM) is compatible with simultaneously assuming cash flow as a GBM, We clarify the above argument with a simple textbook-standard case study.