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Software development typically involves a large capital outlay for an asset with a highly uncertain useful life. A reduction in the degree of uncertainty is likely to have a significant impact upon the expected value of an application. One method for reducing uncertainty is to incorporate modularity (e.g. a portability layer) when the application is first developed. The inclusion of such a layer involves an additional development cost. Using a real options approach we estimate the value of the flexibility that such portability confers. We use sensitivity analysis to examine the relationship between value of portability and changes in factors such as the probability that the application will have to be rewritten, expected application life, and the volatility of future redevelopment costs. Evidence is presented regarding the fundamental requirements necessary to make the additional investment in software design a positive net present value project.

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© 2005 Financial Decisions Associates. Article deposited here in compliance with publisher policies. Publisher's version of record:

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Financial Decisions


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