1. Page 1CS 851 1 March 2002 Case Study An Italian ISV is considering becoming an “adaptive firm” and expanding its customer base outside of Italy. We want to determine the additional value of the flexible reuse infrastructure, among other considerations, before making the investment.

2. Page 2CS 851 1 March 2002 Case Study We will build binomial trees obtain k, the risk-adjusted discount rate calculate standard PV (using DCF) and risk-neutral PV (using CCA) add consideration of options to the analysis

3. Page 3CS 851 1 March 2002 Case Study

4. Page 4CS 851 1 March 2002 Case Study

5. Page 5CS 851 1 March 2002 Case Study

6. Page 6CS 851 1 March 2002 Case Study

7. Page 7CS 851 1 March 2002 Case Study

8. Page 8CS 851 1 March 2002 Case Study S w is an European option, since the option to switch in a given year may be exercised only in that year. We switch markets if we can realize a larger cash flow by switching. Cu i = max(Cu i (FR) – CU(IT) i, 0)

9. Page 9CS 851 1 March 2002 Case Study

10. Page 10CS 851 1 March 2002 Case Study

11. Page 11CS 851 1 March 2002 Case Study

12. Page 12CS 851 1 March 2002 VBRI Value Based Reuse Investment is a framework of four interlinked principles. Economic value maximization drives reuse investment strategies Strategy drives selection of reuse investments Investments are actively structured to maximize embedded strategic options Both DCF and options-based approaches are used to capture the full value of reuse investments

13. Page 13CS 851 1 March 2002 VBRI VBRI encourages a continuous cycle of identification, formulation, and evaluation of strategic options

14. Page 14CS 851 1 March 2002 My Observations The paper covers a lot of ground…the background information is good to have. It’s difficult to maintain focus, though. I like the fact that the authors stress that this approach is not a “cure-all”; we’re cautioned to avoid the “everything is an option” syndrome. Especially after they call expanded NPV and options myopic!

15. Page 15CS 851 1 March 2002 My Observations The approach is constructed well enough so that it can be generalized and applied to other types of software engineering decisions that involve uncertainty and risk. Use of COTS Value of strategic flexibility in projects Making design decisions

16. Page 16CS 851 1 March 2002 My Observations Criticism of the approach includes CCA (and all other arbitrage- based methods) requires knowledge of current asset values and risks such methods are valid only if market priced assets can be found to track risks

17. Page 17CS 851 1 March 2002 My Observations A valuation method needs to include all pertinent characteristics of the asset. Real options are one way of quantifying qualitative characteristic of “flexibility.” Is it possible to go outside of the economic paradigm when making business decisions?

18. Page 18CS 851 1 March 2002 Questions? thank you!