Real Option Valuation 

Because options limit the downside potential of a project, the value of a real option is increased when the uncertainty relating to its underlying asset is greater. Thus, the greater the number of options and the greater the uncertainty surrounding their use, the greater the worth of a project with real options.

To value a real option, the first step is to value the project as if it had no options attached. Next, the various options and possible results are set up using the various possible outcomes. The expected value of the project with the option or options is determined. Possible events may include permanent abandonment, temporary abandonment, varying inputs or outputs, varying the production mix, and so forth.

The project’s NPV with the real option is its value without the real option plus the value of the real option:

Thus, the value of a real option can be determined by calculating the net present value of the project without the real option, then calculating its net present value with the real option, and then finding the difference.