Real options in defense R&D: a decision tree analysis approach for options to defer, abandon, and expand

Abstract

The purpose of this thesis is to demonstrate the benefits of using real options in defense research and development (R&D) projects. To this end, the primary research question, how can real options be used in defense R&D?, is addressed. The thesis provides a comprehensive literature review to substantiate that, in evaluating real options in defense R&D projects, the decision tree analysis (DTA) should be used rather than the real option valuation (ROV). Accordingly, this thesis employs the DTA approach along with the case study method to evaluate the options to defer, abandon, and expand in three simple defense R&D cases. These cases are analyzed first without, and then with, the respective option to demonstrate the increase in the net present value (NPV) of the R&D projects when the real options are used strategically. The results suggest that incorporating real options into defense R&D projects provides decision makers with flexibility, thus improving the project value, and that the value of real options can practically be calculated with the DTA approach. In this regard, the thesis closes an important gap in the literature and provides practitioners with valuable insights.