MOVE FROM TAKING RISK TO MANAGING UNCERTAINTY USING REAL OPTIONS AS A STRATEGIC AND CAPITAL INVESTMENT TOOL. A CASE FOR USING OPTION PRICING MODEL (OPM) TO EVALUATE PROJECT INVESTMENT, 2012 TAPPI PEERS Conference

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The Pulp and Paper industry relies heavily on the traditional Discounted Cash Flow (DCF) based Net Present Value (NPV) for making capital investment decisions. The deficiency of Static DCF-NPV model is that, once a pattern of cash flow is established, the management does not have the option to change the direction as new information are available. However, flexibility to alter the investment decision as and when new information available is a powerful strategic and capital investment tool. Research is abundant in establishing strong precedence for applications of “Real Options” in operational and strategic settings to provide useful insights in the evaluation of irreversible investments under uncertainty. The application of Option Pricing Models (OPM) such as Binomial and the Black-Scholes for strategic planning and capital investment opportunity has been done in other industries but not in the Pulp and Paper industry though the latter is highly capital intensive with historical evidences suggesting poor Return on Investment (ROI) for many implemented capital projects. In this paper a case for using OPM as a strategic and capital investment tool in the decision making process is advocated by using the example of a hypothetical North American mill considering investments to modernize its operation.