Company valuation under interaction in discrete time (real game options model)

Abstract

Company valuation is a crucial topic in financial decision making. The advanced valuation method is the real options approach realised under risk and flexibility. It reflects a stochastic feature of the underlying asset and dynamic managerial decision making. Another aspect of valuation, which is often neglected, is interaction, meaning the mu- tual impact of other companies on the calculated value. Game theory models this aspect. The paper’s objective is to describe and apply company two-phase real game options valuation in discrete time. A generalised real game op- tions valuation model based on the two-phase method, discrete time, risk-neutral probability, and switching cost is formulated. The game categorisation is introduced, especially market structure games, including equilibrium calcu- lations following pure and mixed strategies, and the real game options model is formulated. A company two-phase valuation method in the Cournot production duopoly market structure under random demand is developed, and an illustrative example is presented. The paper confirms the possibility of modelling company two-phase value through real game options valuation models. Neglecting an interaction under a non-perfect market structure can undervalue a company, so this aspect is essential.