The Application Of Real Option Method In Evaluation Of Target Enterprise Value

Enterprise Merger and Acquisition is a hot topic in both economics and industry in recent years. M&A activity has become a frequent phenomenon in the field of economy, and has increasingly become an important means of the enterprise to optimize the allocation of resources. The intrinsic value of the target enterprise in M&A is basis to decise the final transaction price for M&A enterprises, and accurately assess the intrinsic value of target enterprise is the key factor of success of mergers and acquisitions.The traditional evaluation methods in M&A include market approach, income approach and cost approach and the most commonly used method is the discounted cash flow of income approach. Traditional evaluation methods are static analysis methods and does not take into account the value which the uncertainty of the future brings to the enterprise, ignoring the management flexibility,so they are worse to assess the target enterprise value and even may underestimate the value of the enterprise,thus affecting the purchase transaction of M&A. But the real option method is a dynamic analysis method,which regard the M&A strategy as a right of enterprise expansion.The choice option which the enterprise possesses in the uncertain environment is of value, and this value can be quantified. Therefore, the real option theory is applied to the evaluation of corporate value that well make up for the shortage of the traditional method, which provides a new way of thinking for decision makers.This paper first reviews the literatures related to the M&A target enterprise value evaluation and real option, systematically introducing the real option theory, and analyzes the feasibility of the application of real option in the target enterprise value assessment, combined with the characteristics of M&A. This article described in detail the application idea, the choice of computing method and the method for determination of relevant parameters of real option which are applied to the target enterprise value evaluation. Finally, we selected the case that Corporation M merged Corporation N and simulated the whole process of real option applied to the target enterprise value evaluation, then analyzed the result. The real option method provides a new perspective for the assessment of enterprise value, but also has certain limitation. In the end this paper summarized the limitations of the application of real option method in practice and delivered the prospects for the future.