What is the purpose of using a real options pricing model to estimate the potential value of an information systems project?

What will be an ideal response?

Some information systems projects are highly uncertain, especially investments in IT infrastructure. Their future revenue streams are unclear and their up-front costs are high. For example, consider a $20 million investment to upgrade your firm's IT infrastructure. If this upgraded infrastructure were available, the organization would have the technology capabilities to respond more easily to future problems and opportunities. Although the costs of this investment can be calculated, not all of the benefits of making this investment can be established in advance. But if the firm waits a few years until the revenue potential becomes more obvious, it might be too late to make the infrastructure investment. It is in these cases that managers might benefit from using real options pricing models to evaluate information technology investments. Real options pricing models (ROPMs) value information systems projects similar to stock options, where an initial expenditure on technology creates the right, but not the obligation, to obtain the benefits associated with further development and deployment of the technology as long as management has the freedom to cancel, restart, or change the project. ROPMs give managers the flexibility to stage their IT investment or test the waters with small pilot projects or prototypes to gain more knowledge about the risks of a project before investing in the entire implementation. Valuation borrowed from the financial industry.