Modeling And Analyzing Of The Interaction Between Expansion Options And Abandonment Options

We know that when an investment project is running, managers are usually based on the progress of the project as well as market conditions change to make corresponding adjustments to adapt to the new environment. Traditional valuation methods (such as discounted cash flow method) not including the management flexibility, so people gradually put forward a new valuation method after a long-term course of the discussion. The new evaluation method can reflect the value of investment opportunities in the two aspects: first, the project value of discounted cash flow; second, the value of the manager's active management. We usually call this method real option.At present the discussion on the real options are mostly concentrated in valuation of single options, that means a project only include one option. In real life, investment projects generally include a number of real options, so, the interactions of multiple options valuation have a strong practical significance. In this paper, we discussed the interaction of two specific real options (Abandonment options and Expansion options) valuation. We establish models according to the order of the two options expiration date, give an analytic solution of the equations, and finally summarize the whole paper.