Investment Under Uncertainty in Information Technology: Acquisition and Development Projects

Abstract

In this paper, we develop two models for the valuation of information technology (IT) investment projects using the real options approach. The IT investment projects discussed in this paper are categorized into development and acquisition projects, depending upon the time it takes to start benefiting from the IT asset once the decision to invest has been taken. The models account for uncertainty both in the costs and benefits associated with the investment opportunity. Our stochastic cost function for IT development projects incorporates the technical and input cost uncertainties of Pindyck's model (1993), but also considers the fact that the investment costs of some IT projects might change even if no investment takes place. In contrast to other models in the real options literature in which benefits are summarized in the underlying asset value, our model for IT acquisition projects represents these benefits as a stream of stochastic cash flows.