Managerial flexibility using ROV : a survey of top 40 JSE listed companies

For the last 40 years, academics advocated the use of the traditional Discounted CashFlow (DCF) techniques but these suggestions were ignored by practitioners for a longtime. The Net Present Value (NPV), Internal Rate of Return (IRR) and Present ValuePayback Period (PVPP) are now some of the more widely used traditional DCF-basedtechniques, especially among large firms. However, academics are now criticising thesetechniques as they are based on rigid assumptions that ignore the management offlexibility in projects. The Real Option Valuation (ROV) is suggested as an alternativetechnique because it implicitly incorporates this flexibility in project valuation. WithROV, opportunities in projects are treated as real options and are therefore valued usingfinancial option principles. Real options give the firm the opportunity to act on aninvestment project (invest, abandon, rescale) at a later date, when more information isavailable.As with the traditional DCF-based techniques in the past, few firms seem to have adoptedROV despite academics’ recommendations. This study is thus aimed at determiningthrough a survey, whether the largest firms in South Africa, specifically those included inthe JSE/FTSE Top 40 index, are using ROV. Based on the results of the survey, it isconcluded that firms generally do not use ROV as only nine percent of the respondentswere found to be using it. This is largely attributed to managers being unaware of thetechnique, and to some extent, to the technique’s complexity. On the other hand,managers were generally found to recognise the flexibility despite not using ROV,although it was not confirmed whether they quantify this flexibility.