The three most common techniques used are internal rate of return, net present value, and payback. However, net present value analysis has some associated limitations that can result in the value of a project being underestimated. A traditional net present value analysis makes implicit assumptions concerning an expected scenario of cash flows. It also ignores the synergistic effects that an investment project can create. Net present value analysis usually underestimates investment opportunities because it ignores management's flexibility to alter decisions as new information becomes available.
Options allow an investor to determine a dollar value for an event that is to occur in the future.
Historically, options have been used to value future possibilities associated with financial assets such as stocks. The concept of real options is based upon the fact that management does have the flexibility to alter decisions as further information becomes available. If future conditions are favorable, a project may be expanded to take advantage of these conditions. On the other hand, if the future is unfavorable, a project may be curtailed or even canceled as the conditions warrant. A traditional net present value analysis does not take these factors into account.