Estimating Facility Size for Variable or Uncertain Activity Levels

In this article, we propose a model and methodology for valuing the option to delay network investment decisions and calculating cost-based access prices. We model the value of the option to invest in each network element as a function of two stochastic variables: the flow of total variable profit from the service provided by the network element and the cost of new investment in that network element. We calculate the option value multiple to be applied to the investment cost component of three main network elements, conduct sensitivity analyses, and highlight key findings.     

多寡头不确定条件下的矿山企业期权博弈基本价值研究

期权博弈方法把实物期权和博弈论结合起来,在不确定性条件和竞争环境下,为企业提供项目的投资估价和决策,以实现投资项目价值的最大化。竞争环境下的矿山企业博弈参与方不再局限于对称双寡头,而是考虑了序贯均衡阶段的多寡头矿山企业,在进行项目投资决策时,可假设投资初期成本各不相同,建立多寡头矿山企业期权博弈基本价值的价值函数和最佳投资时机进行研究。     

Multikriterielles Entscheidungsmodell für Anpassungsmaßnahmen am Beispiel der L/H-Gas-Umstellung in Deutschland

The German gas supply system is separated into two networks: one for high-calorific gas (H-gas) and one for low-calorific gas (L-gas). In particular, the L-gas volume is declining significantly, which means that there will be problems in security of supply in near future. This paper highlights the most important aspects that have to be considered when adjusting the German gas network to the future decline of L-gas production. First, the article discusses different possible adjustment options: (1) adjustment of market areas from low-calorific gas supply to high-calorific gas supply, (2) blending facilities (conversion of high calorific gas using nitrogen or air) and (3) the combination of both options. Subsequently, the authors outline the necessary planning process that must precede any adjustment option. The so-called network differentiation is followed by the network modeling: Using the net present value method and taking into account certain constraints, the authors define a simple optimization problem to determine the most economical investment and adjustment times for each option. Based on first model considerations it can be concluded that the implementation of adjustment options should be delayed as long as possible without compromising the security of supply. Nevertheless, an early start of the planning process is mandatory to ensure that adjustment options can be established in due time before an L-gas supply deficit occurs. The question, which adjustment option should be chosen, cannot be answered universally. It depends on the conditions and structure of the network as well as the structure of the final consumers.     

ECONOMIC ANALYSIS IN THE MAINTENANCE,REPAIR, AND OVERHAUL INDUSTRY: AN OPTIONS APPROACH

This paper presents a practical case application of the real options framework to a multi-stage investment in the aerospace maintenance, repair, and overhaul (MRO) industry. With the deregulated commercial airline industry and military procurement reform, the $44 billion MRO sector must implement tools to remain strategically poised. In this case study, the MRO participant values a multi-stage irreversible expenditure in maintenance equipment and processes under air travel demand uncertainty using a real options analysis. The investment scenario is viewed from a delay, growth, and compound options framework, and an appropriate sensitivity analysis is performed. The main contribution of this paper is the detailed real option framing, valuation, and discussion that may be used as an illustration for industry practitioners or classroom instruction.     

A Real Options Model of Real Estate Development with Entitlement Risk

Most development projects encounter a highly uncertain entitlement process that is largely uncontrollable by developers. In this study, entitlement is modeled as a separate stage within a compound real option, where developers begin with minimal control (maximum risk) and each successful stage increases control (decreases risk). We solve the model analytically, provide three‐dimensional numerical comparisons, and empirically test the model's predictions using hand collected rezoning petitions. Our main result refines the classic development option model: developers first invest early (secure entitlements) in order to obtain the option to subsequently delay investment (construct the optimal building at the optimal time).     

The role of operational flexibility in the expansion of international production networks

Volatile factor cost developments urge manufacturing firms to increase production efficiency by building up facilities in multiple countries. Differing from previous work that examines the quality of individual locations for investment, the study evaluates the net present value, the growth option value, and the operational flexibility value of the existing production network to predict the establishment of a new site. The results on a sample of 352 German manufacturing firms suggest that the direction, uncertainty, and diversity of labor cost movements in the extant locations influence the propensity to set up a new production subsidiary. Analyzing the international production network after the expansion shows that the new location increases the value of the network regarding these dimensions. Copyright © 2012 John Wiley & Sons, Ltd.     

Time to exit: Rational,behavioral, and organizational delays

Existing studies of exit delay typically focus on rational, behavioral, or organizational explanations in isolation. We integrate these different theoretical explanations, develop testable hypotheses for each, and examine them using the population of US banks between 1984 and 1997. Banks' exit behavior is not consistent with theories emphasizing the option value of avoiding reentry costs. Patterns of exit do, however, support models of rational delay under ability uncertainty. Controlling for this source of rational delay, we find evidence of delay due to behavioral bias—firms discount negative signals of profitability relative to positive signals—and organizational considerations—delay increases with the separation of ownership and control. These results demonstrate that all three sets of theories are necessary to describe exit behavior. Copyright © 2014 John Wiley & Sons, Ltd.     

Real options and real value: the role of employee incentives to make specific knowledge investments

Real options reasoning emphasizes the strategic value of making flexible investments in a turbulent environment. Employees' investments in specific human capital are often critical to the success of a real option project, but the very flexibility that allows a firm to change course in response to new information also affects employees' incentives to make such specific human capital investments. We develop a model of real option investment that explicitly incorporates the role of employee incentives. The model suggests that the effect of investing in a real option project on employee incentives may be positive, further increasing the value of the project, or negative, sometimes more than offsetting the benefit of flexibility and resulting in reduced project value. Therefore, firms and managers should take into consideration the role of employee incentives when applying real options logic to investment decision making. Copyright © 2008 John Wiley & Sons, Ltd.     

Expansion planning for transmission network under demand uncertainty: A real options framework

In recent years, there has been much expectation that transmission expansion planning should address ever increasing demands for transmission services under significant and complex economic and regulatory uncertainties. In this article, toward meeting the aforementioned expectation, we develop and analyze a real options framework that provides the valuation of a transmission owner's option to expand in his or her network. What distinguishes our framework from the extant literature is that the evolution of the demand follows a geometric Brownian motion process, it explicitly accounts for the physical flow of the electric power economically manifested as the locational marginal prices, and it shows how the values of the expansion options can be determined in the transmission network. Furthermore, our framework shows how to value an option to expedite or delay can be determined given that a specific expansion is planned. An extensive numerical example is presented to illustrate the key features of our framework.     

DISCRETE VERSUS CONTINUOUS COMPOUNDING - A NOTE

R&;D projects generally involve multiple phases with or without overlapping. Moreover, the investment is usually made in a phased manner, with the commencement of the subsequent phase being dependent on the successful completion of the preceding phase. The aim of this article is to analyze the equilibrium strategies of two firms competing for a two-stage sequential R&;D investment, when a firm may infer a private signal from the strategy played by the other. Thus, firms must formulate their optimal strategies in a context of imperfect information. We evaluate the resulting compound option with information revelation as an American compound exchange option using Monte Carlo simulations. We then show that different equilibria may arise.     

商业地产投资的实物期权特性及应用框架研究

商业地产开发投资中存在投资的不可逆性、外部环境的不确定性和决策的灵活性，因而具有实物期权特性。从确定要解决的问题、分析不确定性的来源、鉴别关键的不确定性因素、识别实物期权类型、构建期权定价模型、计算项目价值、检查计算结果和重新设计8个方面，构建了商业地产投资决策的实物期权分析框架。     

Investment sharing in broadband networks

This paper presents a model of competition between an incumbent firm and an Other Licensed Operator (OLO) in the broadband market, where the incumbent has an investment option to build a Next Generation network (NGN) and it can do so by making an investment sharing agreement with the OLO, or alone. Two different kinds of investment sharing contractual forms are analyzed, a basic investment sharing, where no side-payment is given for the use of the NGN between co-investors, and joint-venture, where a side-payment is set by the co-investing firms. Results show that investment sharing can potentially be beneficial in terms of competition and investments, but the number of firms involved matters and so does the choice of the NGN access price, for insiders and outsiders of the agreement. Even when the presence of firms outside of the agreement force insiders to compete more fiercely, there might be a concern with the potential exclusion of the outsiders from the NGN.     

Analyzing operational real options in metal mining investments with a system dynamic model

This article presents a detailed system dynamic (SD) model of a metal mining investment that is usable in ex-ante profitability and operations management analysis. We show how the SD model can be used to analyze the profitability effect of three operational real options: the option to temporarily close production, the option to abandon production, and the option to increase production through cutoff grade change. The SD model allows for intuitive modeling of the multiple interactive real options and arriving at results that are difficult, or impossible, to reach with commonly used spreadsheet software. We also analyze the effect of mining project debt ratio to the project value and show that correctly choosing the debt ratio affects project profitability. The effect on the project value of using three different future metal price scenarios with two different stochastic processes is illustrated to highlight the importance of correct process selection in modeling future metal price paths. A realistic case of a high-cost nickel (Ni) metal mine is used as a basis for the presented numerical illustration of the model.     

Analytic solutions for the value of the option to (dis)invest

It is well known that costly reversibility complicates capital investment analysis to the point where closed form expressions for the value of a firm's investment opportunities seldom exist. In such circumstances numerical evaluation is normally taken as the most practical (and often, the only) way of determining investment value. However, we demonstrate that power series expansions can often be used to obtain analytic expressions for the value of a firm's investment opportunities. We use them in a research and development (R&D) setting to determine investment value when cash flows are generated by two well known stochastic processes. The first is based on the Cox, Ingersoll and Ross (1985) 'square root' process; the second on the Uhlenbeck and Ornstein (1930) mean reverting random walk. The criteria which lead to optimal investment decisions when the option to abandon or take up investment opportunities have the non‐trivial values implied by these processes, are also briefly examined.     

An Options Approach to Valuing Expansion Flexibility in Flexible Manufacturing System Investments

Flexibility in manufacturing processes provides an ability to change or even reverse the decisions made in earlier periods. The traditional economic evaluation methods of investments in flexible manufacturing systems ignore the value of flexibility, which should be one of the key issues in the justification process. Options approach appears as a means of overcoming the limitations of conventional discounted cash flow methods. In this work, a methodology for valuing expansion flexibility of flexible manufacturing systems is presented. Expansion flexibility in a phased manufacturing investment can be valued by viewing an initial investment as being analogous to purchasing an option to exchange one risky asset for another risky asset within a time period from the initial investment. While keeping the option to expand is of value, a thorough analysis requires that the opportunity cost of delaying expansion be taken into account. In this paper, an analytic approximation methodology for valuing sequential American exchange options on dividend paying stocks is employed for valuing expansion flexibility. A comprehensive numerical example is presented to illustrate the approach, and sensitivity analyses are performed.     

A review of: “ENGINEERING ECONOMY WITH COMPUTER APPLICATIONS”, by Dr. Arup K. Mnllik,Engineering Technology,Inc., Mahomet,Illinois, 1979, 289 pages,list 517.95.

This paper applies option pricing analysis to the problem of valuing the abandonment option of an investment proposal. The assumption is made that the abandonment option is exercisable at only one point in time in the future and that the project's vatue-in-use and its abandonment value are lognormally distributed. The model is employed to measure how the uniqueness of the project asset, as measured by the correlation between these two lognormal random variables, affects the value of the abandonment option. It is shown that the more unique the asset, or the higher the correlation, the lower is the value of the abandonment option. The model is also employed to examine the impact of increased uncertainty in these two random variables on the value of the abandonment option. The relationships are shown to be nonmonotonic. However, beyond critical thresholds, increased uncertainty in either one of the two variables enhances the value of the abandonment option.     

R&D as an option on market introduction

Discounted cash flow methods for making R&D investment decisions cannot properly capture the option value in R&D. Since market and technology uncertainties change expectations about the viability of many new products, the value of projects is frequently adjusted during the R&D stages. Capturing the adjustment in expectations has an option value that may significantly differ from the Net Present Value of R&D projects. However, there are no historic time series for estimating the uncertainty of the value of R&D projects. As a result, the standard Black and Scholes model for financial option valuation needs to be adjusted. The aim of this paper is to report the application of a particular option pricing model for setting the budget of R&D projects. The option value of the model captures jumps or business shifts in market or technology conditions. The approach originates from applying current insight into the valuation of R&D projects to the field of multimedia research at Philips Corporate Research. This way, the gap between real option theory and R&D practice is further diminished.     

Irreversibility, sunk costs and investment under incomplete information

Despite its importance to economic growth, the investment behavior of firms remains poorly understood. Existing models ignore irreversibility and the opportunity to wait for new information. Even if some recent literature accounts for these two characteristics, these models ignore information costs. This paper presents a framework for the valuation of investment opportunities accounting for information costs regarding the project cash‐flows.
We develop some basic models of irreversible investment to illustrate the option‐like characteristics of investment opportunities under incomplete information. We show how optimal investment rules can be obtained using option pricing theory under incomplete information. It is possible to value real options and investment decisions using our approach in a context of incomplete information. Simulations are provided to illustrate our main results.     

Inflation and Real Estate Investment Value

It is demonstrated that the inflation rate must be reflected in the anticipated benefit flows used in investment value models. When flows are left unadjusted, a biased value estimate results. It is also shown that the actual effects of the inflation rate on investment value will depend on the relationships of original cost, the debt/equity ratio, and the level of depreciation expense. Inflation has a fundamentally negative impact on value traceable to capital gains and depreciation effects. This can be offset by the use of debt financing.     

Riskiness of Real Estate Development: A Perspective from Urban Economics and Option Value Theory

In this article, we define a new construct for urban economic and investment analysis, which revisits the conventional wisdom that investment in real estate development is riskier than investment in stabilized property assets. This new construct, referred as a “development asset value index” (DAVI), is a value index for newly developed properties (only) in a given geographical property market. It tracks longitudinal changes in the highest and best use (HBU) value of locations, and it reveals developer and landowner behavior taking advantage of the optionality inherent in land ownership. In particular, the DAVI reflects developers' use of flexibility in the exercise of the call option to (re)develop the property to any legal use and density. We empirically estimate a DAVI for commercial property (i.e., central locations) and compare it with a corresponding traditional transaction‐price‐based property asset price index (PAPI) corrected for depreciation. We believe that the difference primarily reflects the realized value of flexibility in land development. We find that the DAVIs display greater value growth and are smoother over time and less cyclical than their corresponding PAPIs for the same locations. This suggests that developers successfully use flexibility, and that development may be riskier than stabilized property investment due primarily only to leverage effects (construction costs). Practical implications are also discussed.