PAPER TITLE PAPER URL TOPIC LastName FirstName affiliation Email Abstract
2008-01-25 15:11:51
Real Options and the Regulation of Brazilian Fixed-Line Telephone Operators: The Markup on the Cost of Capital Rocha Katia - Rocha ROC 2008.pdf Agency Rocha Katia IPEA & PUC-RIO DEI This study argues in favor of the real option methodology to calculate the access price for Brazilian fixed-line phone operators. The new cost-oriented regulatory framework for interconnection of telecommunication networks, established in 2005, poses questions regarding the adequate remuneration of investments. By investing in a fixed-line telephone network while giving access to new entrants, the incumbent is actually providing an option to access its infrastructure. Since options aren’t costless, to properly compensate the investment, an effort to estimate the option premium is justified. We suggest a pragmatic approach where the real options rationality appears as a markup over the sector’s cost of capital. Failing to consider the real option granted by incumbents discourages investment in infrastructure in the sector and hinders the intertemporal maximization of social welfare.
2008-01-28 08:03:07
Valuation of a Real Options Portfolio Mogollon Monroy Luis Alfredo - Valuation of a Real Options Portfolio ECOPETROL S.A.pdf Strategy Mogollon Monroy Luis Alfredo ECOPETROL S.A. This study aims to define a methodology supported in the concept of Real Options that will allow measuring the impact of variations in the execution of projects, on the value of the investment portfolio of the Production Vice-presidency of Ecopetrol S.A. (PRV). The proposed methodology involves the classification of the potential value of the Real Options and the valuation of the same using the Binomial method, the Montecarlo simulation, and the calculation of explicit volatility; while proposing the 3D graphic representation of the so called portfolio of Real Options.
2008-01-28 17:23:35
A methodology to evaluate an option to defer an oilfield development Kaffel Bilel - option to defer New version .pdf Case Kaffel Bilel University of Sfax, Tunisia UR: MO.DE.S.FI The purpose of this paper is the valuation of an option to defer an oilfield development. A methodology is implemented in order to choose the appropriate continuous-time stochastic processes for these risk factors: the crude price, the convenience yield and the risk-free interest rate. The analysis reveals that the convenience yield follows a mean reverting process, the oil price is better fitted by the Geometric Brownian Motion with jumps and the risk-free interest rate can be considered constant. The valuation of the option to defer is based on the Monte-Carlo simulation adapting the Least-Squares simulation method for valuing American type options. Results indicate that using multi-factor pricing models leads to reject the project contrary to the one-factor pricing model which leads to later investing at the option maturity.
2008-02-01 10:04:04
High Speed Rail Transport Valuation with Multiple Uncertainty Factors Pimentel Pedro - HSR 3S V1.9.pdf Valuation Pimentel Pedro Universidade dos Açores, DEG The present paper investigates the process of decision making regarding the optimal timing to invest in the high speed rail (HSR) project, under uncertainty, using the real options analysis (ROA) framework. It’s developed a continuous time framework that allows a solution to the problem concerning the optimal timing to invest and to value the impact of the option to defer in the overall valuation of the project, with multiple uncertainty factors. Besides considering a stochastic demand, the effect of uncertainty in the investment’s expenditure and over the benefit per user is incorporated in a model with three stochastic variables. The modelling approach used is based on the differential utility provided to railway users by the HSR service.
2008-02-06 14:28:16
Some general results about the optimal timing of relocation Couto Gualter - paper2 blind general.pdf

Couto Gualter - paper2 JAPGCCN general.pdf
Valuation Couto Gualter University of Azores In this paper we derive general results concerning the optimal switching level in the problem of the optimal relocation policy for a firm that faces two types of uncertainty: one about the moments in which new (and more efficient) sites will become available; and the other regarding the degree of efficiency improvement inherent to each one of these new, yet to be known, potential location places. In particular, we note that the optimal switching level depends on the distribution of the degree of efficiency improvement only through an expected value. Impacts on the final results driven by the characteristics of the firm’s original location site, the market environment and the way in which risk is modelled are studied numerically. The overall results are in line with economic intuition.
2008-02-11 04:01:03
International Monopoly under Uncertainty Aray Henry - version ije sent.pdf Valuation Aray Henry A domestic monopolistic firm has the option to service a foreign market through export or by setting up a plant in the host country under exchange rate uncertainty. We analyze the effect of the parameters of the demand and cost functions on hysteresis. We also show results on the effect of taxation and labor cost in attracting or avoiding relocation. We find that when the firm is multinational it pays more taxes. Much more importantly, a tax rate reduction is effective in attracting investment and avoiding relocation. When the firm is multinational it also incurs lower labor costs. However, labor cost is not determinant in the location of production.
2008-02-12 10:43:48
The fuzzy value of patent litigation AGLIARDI ELETTRA - AGLIARDI ELETTRA - AGLIARDI.pdf RandD AGLIARDI ELETTRA UNIVERSITY OF BOLOGNA and RCEA ABSTRACT. The vague notion of "probabilistic patents" (Lemley and Shapiro, 2005) is formalized through a model which combines real option theory and a fuzzy methodology. The imprecise ideas the patent holder possesses about her future profits, the validity and scope of the patent, the litigation costs, the court's decision. etc. under a regime of imperfect enforcement of property rights are specified using a more appropriate and promising concept of uncertainty through the theory of fuzzy sets. Such methodology is embedded within a real option approach, where the value of a patent includes the option value of litigation. We study how the value of a patent is affected by the timing and incidence of litigation. The main results are compared with the empirical findings of previous results.
2008-02-14 03:46:18
A Real Options Perspective On R&D Portfolio Diversification Van Bekkum Sjoerd - A REAL OPTIONS PERSPECTIVE ON R D PORTFOLIO DIVERSIFICATION Van Bekkum Pennings Smit.pdf RandD Van Bekkum Sjoerd Tinbergen Institute, Erasmus University Rotterdam This paper shows that the presence of conditional staging in R&D (Research & Development) has a critical impact on portfolio risk, and changes diversification arguments when a portfolio is constructed. When R&D projects exhibit option-like characteristics, correlation between projects plays a more complicated role than traditional portfolio diversification would suggest. Real option theory argues that research projects with conditional phases have option-like risk and return properties, and are different from unconditional projects. We show that although the risk of a portfolio always depends on the correlation between projects, a portfolio of conditional R&D projects with real option characteristics has fundamentally different risk than a portfolio of unconditional projects. Intuitively stated, diversification is of not much use when projects are conditionally staged. When conditional R&D projects are negatively correlated, portfolio risk is hardly reduced by diversification. When projects are positively correlated, however, diversification is more effective than these tools predict.
2008-02-18 01:53:07
Applying Least Squares Monte Carlo Method to Value Petroleum Assets in Indonesian PSC Regime --- Case Bachrudji Nuzulul Haq MEDCO E&P INDONESIA Indonesia has many potential undeveloped reserves and currently still depends on petroleum resources to support its economy. However, the economic criteria for investment decision making are still based on the traditional Discounted Cash Flow (DCF) rather than Real Option Valuation (ROV). The need for the ROV approach in valuing petroleum assets is essential for stimulating growth of petroleum resource development in Indonesia. After introduced in 2001 by Longstaff and Schwartz, the Least Squares Monte Carlo (LSM) Method had been extensively applied in natural resource industry (Sabour et al. 2006, Laughton et al. 2006). Since natural resource industry has multiple source of uncertainty from below and above ground factor, this methodology is suitable to be applied in this industry. This paper examines the application of ROV to value petroleum assets in Indonesia using LSM Method. This paper will use real case study from one PSC blocks acquired by Medco in the end of 2001 and compare the result between forecast value from both methodologies (DCF and ROV) and the actual cash flow generated since acquisition. This paper concludes that ROV can be applied to the Indonesian PSC regime. ROV is more likely to reveal a true picture of the worth of petroleum assets in Indonesia than any other currently available technique. As such, it has the potential to form a proper basis for investment decision making, as a result of which production of the undeveloped reserves in Indonesia can be stimulated
10 2008-02-18 03:23:00 Real Options, Debt Financing, and Competition Nishihara Michi - debtcompetition2.pdf Strategy Nishihara Michi Center for the Study of Finance and Insurance, Osaka University This paper investigates firm values and investment strategies (investment, coupon, and default timing) when several firms make strategic real investments with debt financing. We derive and compare the equilibrium investment strategies in three types of duopoly: (i) two symmetric firms, both of which can issue debt, (ii) two symmetric firms, only one of which (the leader) can issue debt, and (iii) a levered firm versus an unlevered firm. We show that in (iii) and in equilibrium, the levered firm always invests prior to the unlevered firm. Further, we derive the equilibrium in the competitive situation of n levered firms, and show that social loss increases as the number of the firms, n, becomes larger.
2008-02-19 02:51:59
REAL OPTIONS AND THE ADOPTION OF TRANSGENIC CROPS: AN INTERTEMPORAL PERSPECTIVE Scatasta Sara - real options 2008.pdf Resources Scatasta Sara Centre for European Economic Research (ZEW) Recently, the impact of irreversibility and uncertainty on the decision of adopting transgenic crops has been assessed using the real option approach. This approach explicitly considers irreversible effects and uncertainties for the valuation of a new technology. This information is important for the risk management of new technologies as it provides a conceptual guideline for decisions makers on whether or not introducing a new technology. The real option approach pegs the decision making process to a particular point in time. As time passes new information may become available and results from previous real options based ex-ante assessments needs to be updated. Based on field trials, and data from the Eurostat this study applies a real option approach to quantify, ex-ante, the maximum incremental social tolerable irreversible costs (MISTIC) that would justify immediate adoption of Bt and Ht maize in the European Union at different points in time. The analysis is carried out for different years over the period 1995 to 2004. Preliminary conclusions are drawn about the MISTIC intertemporal development path and the importance of this path in using real option values to model the economic benefits of introducing transgenic crops.
2008-02-20 04:22:46
A real options approach for evaluating the implementation of a risk sensitive capital rule in banks Nordal Kjell B. - Nordal ROconference 2008.pdf Agency Nordal Kjell B. Norges Bank I evaluate a bank’s incentives to implement a risk sensitive regulatory capital rule. The decision making is analyzed within a real options framework where optimal policies are derived in terms of threshold levels of risk. The bank’s customers, lenders, and other outsiders may influence the optimal decision. Outsiders may make it optimal for the bank to implement the risk sensitive rule earlier than it otherwise would have preferred. I provide numerical example for the implementation of internal rating based models for credit risk (the IRB-approach) under the new Basel accord (Basel II).
2008-02-20 08:58:57
Entry and Exit Decision Problem with Implementation Delay: The Probabilistic Approach Taschini Luca - MS LT Feb08.pdf Strategy Taschini Luca University of Zurich Using the probabilistic approach we analyze the investment and disinvestment decisions under the Parisian implementation delay. We prove the independence between the Parisian stopping times and solve the constrained maximization problem obtaining an implicit solution for the optimal investment level and an explicit one for the optimal disinvestment level. A sufficient condition for solving the unconstrained maximization problem and obtaining the Parisian optimal-levels correctly ordered is derived. Also, an interesting contact with Wald's identity is discussed. Finally, comparing the results with the instantaneous entry and exit case, we show that an increase in the uncertainty of the underlying process hastens the decision to invest (disinvest), extending the results of the current literature.
2008-02-20 10:09:22
Evaluating Cash Benefits as Real Options for a Commodity Producer in an Emerging Market Aiube Fernando Antonio Lucena - Cash Benefits as Real Options.pdf Valuation Aiube Fernando Antonio Lucena Petrobras/PUC-Rio The amount of cash a firm should maintain is an old problem tackled by finance literature. The recent advances in finance, mainly in the derivatives area, has opened the opportunity to revisit this subject. Cossin and Hricko (2004) studied the benefits of cash holdings using the Real Options approach. We follow their ideas extending the problem to a specific commodity producer firm. We evaluated the benefits considering that raising capital takes time and also the benefit of the avoiding the issue of securities at unfavorable moment. We used numerical procedures to solve the problem. Despite the fact that the results are not totally intuitive, we verified that the timing benefit is much more relevant than that of avoiding underpricing benefit and that firms in emerging economies have greater advantage holding cash than those in developed economies.
2008-02-20 16:11:30
New Tecnology Adoption Games: An Application to the Textile Industry Azevedo Alcino - ROConferencePaper2008.pdf Strategy Azevedo Alcino Manchester Business School In this paper we use three real option models to determine the optimal adoption time of a new technology in two Portuguese textile companies, Lameirinho and Coelima. In the derivations of the models we take into account both uncertainty and competition. In the first model, we decompose the uncertainty into two types: market and technical uncertainty; in the second model, we subdivide the uncertainty into three types: market, technical and technological; and in the third model, we consider only market uncertainty, but in a context where there are two technologies available whose functions are complementary. In all models we assume that there is a first-mover advantage and derive analytical expressions for the leader and the follower value functions, and their respective investment trigger values, in a game-choice setting considering the pre-emption effect. Our results show the importance of considering technical uncertainty when adopting a new technology whose reliability cannot be fully tested in a laboratory before adoption, illustrate the influence of the technological progress on new technology adoption time, and emphasize the effect on optimal time of adoption of complementary aspects of two technologies on their.
2008-02-21 05:05:35
Design of a Maritime Security System under Uncertainty Using an Evolutionary Real Options Approach Zhang Stephen - Real Option Conf Paper GA and MC.pdf Infrastructure Zhang Stephen This paper presents an evolutionary real options model of optimization by genetic algorithms and Monte Carlo simulation, to select the best maritime domain protection system configuration and a corresponding adaptive plan with the right amount of flexibilities to address uncertainty. Monte Carlo simulations enumerate diverse terrorism threat paths, decision trees identify possible system (re)configuration and dynamic adaptive plans, and genetic algorithms evaluate and select near optimum solutions, acquiring and exercising the right real options at the right time. Genetic Algorithms are effective and efficient in both compositing suitable pieces of real options and formulating the overall dynamic strategy plan to adapt to various paths future may take. As the whole modelling approach is integrated, many interesting system properties emerge.
2008-02-21 05:07:46
Pricing Real Options under the CEV Diffusion Dias Jos_ Carlos - DiasNunes perpetualCEV.pdf Strategy Dias José Carlos ISCAC Business School Much of the work on real options assumes that the underlying state variable follows a geometric Brownian motion with constant volatility. This paper uses a more general assumption for the state variable process which may better capture the empirical observations found in the financial economics literature. We use the so-called constant elasticity of variance (CEV) diffusion model where the volatility is a function of the underlying asset price and provide analytical solutions for perpetual American-style call and put options under the CEV diffusion. When the constant risk-free interest rate r is different from the dividend yield q, the perpetual American option price is based on an infinite series of terms involving confluent hypergeometric functions. For r = q, the computation of the perpetual American option formula involves the use of modified Bessel functions. We demonstrate the implications of the correct specification of the underlying state variable process for the valuation of real assets and show that a firm that uses the standard geometric Brownian motion assumption is exposed to significant errors of analysis which may lead to non-optimal investment and disinvestment decisions.
2008-02-21 06:34:17
The Impact of Real Options on Willingness to Pay for Infrastructure Safety Investments Krueger Niclas - KruegerSvensson.pdf Infrastructure Krueger Niclas Örebro University/Karlstad University, Sweden Public investments are dynamic in nature, and decision making must account for the uncertainty, irreversibility and potential for future learning. In this paper we adapt the theory for investment under uncertainty for a public referendum setting and perform the first empirical test to show that estimates of the value of safety (VSL) from stated preference surveys are highly dependent on the inclusion of the option value. Our results indicate an option value of a major economic magnitude. This implies that previously reported VSL estimates, used in societal benefit-cost analysis of infrastructure investments, are exaggerated.
2008-02-21 07:47:10
A Model of Brand Choice and Purchase Incidence: A Real Options Approach Suzuki Hiroto - suzuki.pdf Strategy Suzuki Hiroto Waseda University We develop a model of consumers’ purchase behavior under uncertainty of price by using real options approach. Retailers, discount stores and super markets, frequently conduct price promotions, and the promotions to stockpile products are frequent, too. In that category, there are trends to purchase at lower price, and postpone the purchase at higher price. That is, they make decision to purchase or postpone by their memory of the past price and the actual price. In the other word, under price uncertainty, they make the decision considering the options value to postpone purchase. Therefore we develop a consumers’ purchase incidence and brand choice model considering postpone options by using real options approach.
2008-02-21 08:28:25
Strategic and Operational Real Options in Area Development Projects: Collan Mikael - mc areadev.pdf Infrastructure Collan Mikael IAMSR, Åbo Akademi University Area development projects are multi-million euro construction projects that aim for relatively large areas to be constructed in a concentrated time frame. Finnish municipalities have tended to favor area development projects due to the related normally positive indirect cash flow effects for municipalities, e.g., positive tax income effects, and the fact that they speed-up the municipal development. Area development projects, however, also cause risks to the municipalities in the form of possible changes in the population demographics in the developed areas, which in turn may cause negative cash flows. As most municipalities in Finland are facing tight financial times (AD 2008) they may be very risk averse. This may cause reluctancy to favor the start of new area development projects, which again delays municipal development, and may even delay growth in the aggregate level. This paper will describe the traditional (present) policy models for Finnish municipalities, vis-à-vis area development projects, and the creation of new policies through an analysis of high level (strategic) real options available to municipalities to change their role in these projects. The extension of the municipalities’ involvement in the area development projects and active tracking of the available real options reduces municipalities’ risks and enhances returns.
2008-02-21 09:24:29
The Ethanol-Gas Flex Fuel car: What is the option value of choosing your own Fuel? Bastian-Pinto Carlos - The Ethanol Gas Flex Fuel car What is the option value of choosing your own Fuel.pdf Case Bastian-Pinto Carlos Pontifícia Universidade Católica - PUC Rio de Janeiro - Brazil Renewable energy sources are becoming more important as the world’s supply of fossil fuels decrease and also due to environmental concerns. Since 2003, when the ethanol-gasoline flex fuel car became commercially available in Brazil, the growth of this market has been significant, to the point where currently 40% of the fuel consumption in Brazil is from renewable biofuels. This has been made possible due to the success of the flex fuel car, which can run on ethanol, gasoline, or any mix of these in the same fuel tank, and which is sold at a premium over the non flex models, Flex fuel cars, on the other hand, provide the owner with the flexibility to choose fuels at each refueling stop. Given the uncertainty on future prices of ethanol and gas, this option adds value to the owner since he can always opt for the cheaper fuel whenever he fills up his car. We use the Real Options method to analyze the value of the flex fuel option assuming both a Geometric Brownian Motion and Mean Reverting diffusion processes and compare the results for both methods. We conclude that the flex option value is significant using either method and twice as high as flex premium charged by the car manufacturers, which help explain the success that this type of automobile has enjoyed in Brazil since 2003. Our results also indicate that consumers should be wiling to purchase flex fuel cars even if manufactures increase the flex premium.
2008-02-21 09:42:23
Entry and Exit Decisions under Uncertainty in a Symmetric Duopoly Goto Makoto - goto.pdf Strategy Goto Makoto Waseda University In this paper, we analyze entry and exit decisions in a symmetric duopoly setting.The model is based on Dixit (1989), which is a standard model in this area. To incorporate competitive nature into the output price, we use an inverse demand function. We aim to present an equilibrium strategy of entry and exit decisions in a symmetric duopoly. To do so, we consider four states of two firms and pay attention to setting the value-matching and smooth-pasting conditions. As a result, the relation between four optimal thresholds is shown. Moreover, we show that a competitive exit threshold has different characteristics from others.
2008-02-21 11:20:59
The Valuation of Expanding and Withdrawing Option Embedded in License Contract Ito Haruyoshi - The Valuation of the License paper Submission.doc RandD Ito Haruyoshi Keio University In this paper, we intended to calculate the rational value of license contracts by real option approach which takes into account the value of expanding and withdrawing options which are not taken into account by previous method, DCF method, by using the case of business tie up between Le Coteau Vert Co., Ltd. (CV) and NORTHROP GRUMMAN Space & Mission Systems Corp(NGMS)related to the license contracts aboutìDISC Flex Filter. We calculate the rational value of license contracts by taking into account expanding and withdrawing option. In this case, we have to pay attention to how to sum up the value of expanding option and withdrawing one. In this paper, we use Monte Carlo Simulation method calculating rational value of license. This research surely help both managers who intend to invest in new business fields by purchasing license and licensor who sell and decide the rational value of license contracts. In addition, this research also help to decide rational compensation for damages related to patent which are concurrently occurred in the trial.
2008-02-21 12:10:49
USO DE OPÇÕES REAIS PARA PRECIFICAÇÃO DAS GARANTIAS DE CONTRATOS: O CASO DO EXPRESSO AEROPORTO Oliveira Fernando - Uso de Op es Reais para precifica o das garantias de contratos O caso Expresso Aeroporto VFinal.pdf Infrastructure Oliveira Fernando Central Bank of Brazil and IBMEC/RJ Infrastructure’s investment in Brazil is a fundamental factor to the maintenance of the economic growth of the country. However, these investments have high regulatory, macroeconomic and market risks, which reduce its attractiveness to new investors. To mitigate these risks, the Brazilian government proposed guarantees concessions to stimulate the private sector participation in the high speed highway Expresso Aeroporto project. The real options theory will be used to value these guarantees, as it includes in its methodology the possibility of uncertainty and management flexibility. The project’s valuation using the real options theory will follow four steps: estimation of the project’s present value using the traditional methodology of discount cash flow, use of Monte Carlo simulation to determine de project volatility and the event tree construction using binomial model, incorporation of management flexibility to define de decision tree and analysis of the real options. The results obtained for the expanded net present value of the project considering the real options, is R$ 449.047 mil, an increase of 131% in comparison with the traditional present value.
2008-02-21 13:01:15
A Real Options Model for Closing/Not Closing a Production Plant Carlsson Christer - A Real Options Model for Closing or Not Closing.doc Strategy Carlsson Christer IAMSR/Abo Akademi University The closing/not closing decisions for a production plant normally worries senior management as their decision will be scrutinized and criticized by many groups of influential actors. Real options models will support decision making in which they search for the best way to act and the best time to act. The key elements of the decision may be known only partially and in imprecise terms which is why we show that meaningful support can be given with a fuzzy real options model. The decision process and its consequence are worked out in terms of a real case in the forest products industry; this case is worked out in detail with realistic data.
2008-02-21 13:08:31
Exploring Real Option Analysis in Nuclear Energy Assessment Studies L_uferts Ulrike - Exploring Real Option Analysis in Nuclear Energy Assessment Studies L uferts.pdf Infrastructure Läuferts Ulrike NRG The application of Real Option Analysis (ROA) isn’t yet widespread in the nuclear industry. Although there are interesting approaches from the academic side, the economic potential of nuclear is still assessed by classical discounted cash-flow (DCF) calculation, often based on crude heuristics, negative experience from past like projects and unconscious bias of the assessing team. Due to high front-up costs, hurdle rates far above average and uncertainty about future revenues, undervaluation of nuclear projects is the consequence of not being able to quantify the strategic potential of this technology. Although generating technologies using fossil fuels come along with high sensitivity towards fuel prices and carbon taxes, there are only some 30 new nuclear power plants under construction, only two of these in Western Europe and US. A worldwide increasing number of license applications suggest that utilities are being aware of the strategic benefits of nuclear, yet in the western hemisphere they intuitively exercise the option to wait until some of the institutional uncertainty has cleared off. Against common understanding, the nuclear fuel cycle is full of optionalities. If spent nuclear fuel is a liability or a valuable source of energy depends mainly on how the nuclear industry is able to add a positive economic value on an infrastructure of advanced nuclear systems. To go ahead and consequently take current Gen-III technology into a transition towards more sustainable systems, modern analytical methods need to be applied to reveal the economic potential and feasibility. This paper gives a short overview about the levelized cost of electricity resulting from classical evaluation methods, comparing Light Water Rector, Fast Reactor and the modular High Temperature Reactor technology. In a second step optionalities are being drafted qualitatively, a) pointing at the value of current technologies in a portfolio based approach and b) revealing choices and opportunities in the transition to a deployment of advanced nuclear systems. By using a quantitative, consolidated approach, it can be demonstrated that a new generation of modular design can add value by reducing sales risk and adding market liquidity. The result is being compared with an economy of scale design, a technology that is only deployed under current market conditions if long term power purchase agreements come along with the investment. Proceeding from the flexibility bonus evaluated in this Real Option Analysis, a fair discount rate for large industrial end users is being discussed, if market participants are willing to enter into bilateral off take contracts to hedge against the volatility associated with electricity markets.
2008-02-21 13:12:48
Real options approach for evaluating an Internet service on trains rollout Van Ooteghem Jan - Real Options vanooteghem final.pdf Case Van Ooteghem Jan Ghent University - IBBT Internet on the train has gained more and more interest in the railway sector in the last few years. The attraction of potential new rail customers is mostly envisaged by the railway companies, and in this way Internet services to train passengers is seen as a major opportunity. First we discuss our generic business model to evaluate and compare diverse technical scenarios, for guaranteeing a continuous network connection. To obtain real figures, our model is applied on the Belgian railway network, and we have performed a general cost/benefit analysis for the different technical scenarios. A sensitivity analysis shows then the most influencing parameters in our model. Based on this information we have created a real options calculation method for optimizing the rollout scheme, as this was originally kept fixed. By introducing certain flexibility in the rollout schemes, the viability of an Internet on the train rollout can be seriously optimized.
2008-02-21 15:06:57
An analytical real option replacement model with depreciation Adkins Roger - Article B revD.pdf Growth Adkins Roger SBS, University of Salford A replacement model is presented for a productive asset subject to stochastic input decay, tax allowances due to a deterministic depreciation variable, and a fixed investment cost. The risk neutral valuation function is formulated and optimal trigger levels signalling replacement for the two factors is determined analytically although not as a closed-form solution. We demonstrate that the operating cost trigger level depends on asset age and increases monotonically due to positive volatility changes and that the model solution furnishes the results for certain special cases. The analysis is conducted both for a depreciation schedule specified by the declining balance and straight line method. The comparative analysis shows that although no universal ideal depreciation schedule exists between the two, the declining balance method is preferred. Finally, the solution method is sufficiently tractable to be applied in principle to real option models where time is a critical factor.
2008-02-21 15:26:06
Option to Abandon Non-Core Part of Company Acquisition Collan Mikael - OptiontoAbandonNonCore.docx Valuation Collan Mikael Institute for Advanced Management Systems Research, Åbo Akademi University This paper discusses the before-acquisition-analysis of potential target companies that have substantial assets, which are not the core-business of the acquiring company. The background work for this paper is done in cooperation with corporate managers from a multinational company. The perspective is an active acquirer’s focusing on non-public acquisition targets operating in the same industry with the acquirer. The problem is to screen and value potential non-public acquisition target companies including non-core business parts using only in-house resources at this point. The paper concentrates on the trade-off between the costs and benefits of acquiring a company with substantial non-core business assets. Number of key driving factors important in the analysis are identified and discussed; some arising rules of thumb are presented. Non-core-business assets are analyzed as an option to abandon. Different ways to abandon, including asset liquidation, MBOs, and LBOs, are included in the analysis. We apply discounted cash flow valuation, firstly, separately for the core-business and the non-core business parts, and then combine the values in a scenario framework. This is done using a spreadsheet decision support system also presented in the paper. We further present a simple way to turn the constructed scenarios into a binomial decision tree. This is done using yearly decision nodes on scenario space and finding the lacking decision nodes between the scenarios by interpolation. The simple method is compared to the risk neutral approach to construct a lattice. The abandonment nodes are presented graphically both in a scenario space as well as in a lattice based on the presented real option model. An example case with numerical data is presented and used to illustrate the discussed issues and the model. Keywords: Acquisitions, non-core business assets, real option, option to abandon, decision support system
2008-02-21 16:41:53
The Tourinho model: Neglected nugget or receding relic Adkins Roger - Article H A.pdf Resources Adkins Roger SBS, University of Salford As one of the earlier contributors to the body of real options literature, the Tourinho model on oil shale extraction is assessed for its legacy. His risk neutral investment deferral model elicits an extraction paradox of infinite deferral and no extraction. Although this is remedied by introducing an option holding cost or a time dependent rising investment cost, it is established that the source of the difficulty is due to the absence of a convenience yield. We demonstrate that by including a convenience yield in the holding cost deferral investment model, the resulting solution lies somewhere between the Marshallian zero volatility solution and the standard real option investment deferral solution. Option holding costs are infrequently adopted in real option models, but they represent a continuous cost of keeping an option alive and are characterised by land taxes prior to real estate development, rents prior to resource extraction and ongoing costs to sustain a technological edge before market release. Their consequence is to accelerate the value level triggering investment. Similar results are obtained for a stochastic investment cost.
2008-02-21 16:52:47
Separating ambiguity and volatility in cash flow simulation based volatility estimation Haahtela Tero - HaahtelaROC2008.pdf Computational Haahtela Tero Helsinki University of Technology Volatility is a significant parameter both in financial and real options valuation. However, in the case of several real option projects there is no historical data available. In such cases, one alternative is to use Monte Carlo simulation on projects’ cash flows for volatility estimation. An important issue that has not been taken into account with most of these volatility simulation procedures is that not only the volatility but also the value of the underlying asset is often uncertain with ambiguity in the beginning. Because most of the existing methods do not take this into account, they overestimate the actual volatility of the project. This paper presents a procedure that separates the underlying asset uncertainty in the beginning from the volatility and hence improves the volatility estimation.
2008-02-21 17:13:17
Valuation of Flexibility in Optical Layer Network Planning: a case study for a Belgian network Verbrugge Sofie - Verbrugge - roconf2008 - vSUBM.pdf Case Verbrugge Sofie UGent/IBBT - IBCN This paper discusses the economic evaluation of different fiber deployment scenarios on the optical network layer, based on dark fiber and wavelength lease. Upfront planning based on predicted traffic leads to a network expansion plan which is probably not optimal for the actual traffic evolution. Real Options valuation determines the value of choosing a certain network deployment scenario, taking into account the ability to switch to another scenario based on information that is unknown upfront, but becomes available during the course of the planning horizon. Based on realistic assumptions for equipment and lease contract costs in a case study for a Belgian network, we show that dark fiber lease provides the most cost efficient solution. An Indefeasible Right of Use on dark fiber allows to cope with growing traffic without the need to update the contract immediately, however, its long contract term is little flexible and therefore in general not beneficial in case of uncertain traffic evolutions. Lambda lease was shown to benefit from its flexibility switch fast to another network scenario in case of uncertain traffic evolutions.
2008-02-21 17:15:34
Valuation of Investments in Flexible Power Plants: A Case Study in the Brazilian Power Market Aronne Alexandre - AronneRO.pdf Case Aronne Alexandre Fundacao Pedro Leopoldo In this paper, we discuss the real options valuation of investments in flexible power plants. After the Brazilian energy supply crisis in 2001, new investments in gas-fired power plants were made to increase electricity generation in the short term, due to the reduced maturity time of these investments. More recently, the nationalization of the Bolivian natural gas reserves raised uncertainties over prices and supply of this commodity. Initially we analyze an operating power plant that can switch fuels among natural gas and oil and afterwards we study the option to temporarily shut down the plant. Finally, we assess the interaction between these two options and determine the optimal operating policy of the plant. The valuation method used involves the use of two quadrinomial trees, supporting correlated GBM for the fuel prices.
2008-02-21 17:30:39
Determining the Volatility and the Delay Option of a Petrochemical Project in Brazil Marques Alberto - Petrochemical Industry Paper.pdf Case Marques Alberto Petrobras The Real Option Theory (OR) offers a modern methodology for the valuation of an investment project because it considers the value of managerial flexibility facing project uncertainties. The present work seeks to study the deferral option value for a polypropylene petrochemical plant investment project. Perhaps the most critical step of OR is the estimation of the project volatility. This work estimates the project volatility for different cases, considering different possibilities for the uncertain variables modeling. The main uncertain variables are the price of the raw material and the price of the product. Three possibilities for price modeling were considered: Brownian Geometric Movement (BGM), Mean Reversion (MR), and Mean Reversion with Jumps (MRJ). A base case was selected for the volatility project and then the value of the deferral option was calculated through numerical approximations of the Black - Scholes partial differential equation.
2008-02-21 17:45:46
Incorporating risk and flexibility in manufacturing footprint decisions Pergler Martin - 0802 footprint v2.pdf Case Pergler Martin McKinsey & Company martin An increasing number of manufacturers are significantly reshaping their global manufacturing footprint, including radical increases in offshore production in low-cost countries and fundamentally rethinking their sourcing strategy. Too often, such footprint choices are made based primarily on their expected capacity and cost implications, without taking adequately into account the equally important aspects of risk, flexibility, and competitive positioning. As a result, companies leave value on the table from failing to make the right cost-risk-flexibility tradeoffs. This paper illustrates (with real-life case examples) some of the pitfalls companies have encountered, and outlines a more holistic approach that includes systematically identifying the key uncertainties and flexibility factors and quantifying their impact. This approach includes real options-related techniques incorporated into probabilistic risk modeling and footprint optimization.
2008-02-21 17:52:36
Optimal incentives to public-private partnerships for airport investments under market segmentation Rodrigues Artur - apr2008 - airport.pdf Infrastructure Rodrigues Artur University of Minho This paper analyzes how certain incentives given to private airport concessionaires should be optimally determined to promote immediate investment, in a real options framework. Recognizing the recent and increasing trend of low cost airlines, we value different investment strategies comparing a single airport, serving two types of demand, with segmented airports, and their implications for defining optimal incentives. We also show that both strategies dominate for different ranges and that there is an incentive to delay the choice of the best alternative when both strategies produce closer values.
2008-02-21 22:29:18
Private Equity Arrangements as Real Options Kensinger John - PrivateEquityRO.pdf Strategy Kensinger John University of North Texas The premise of this discussion is that private equity players intend to create real options that maximize the value derived from potential movement in the worth of the underlying business platform. This intended maximization occurs when the current value of the exercise instrument equals the current value of the underlying asset (so the option is at the money). It is also clear that when the time horizons of different arrangements tend to be consistent (as tends to happen in private equity arrangements) the attraction will be for higher volatility. The actions often criticized in the media are readily understandable in this context. For example, private equity is criticized for “borrowing heavily to buy companies, breaking them up, and selling off the pieces at huge profits.” Even before exiting, the private equity players separate the acquisitions into business units and asset pools. This changes an option on a portfolio into a portfolio of options, and we know from option pricing theory that result is worth more than the starting point. Private equity has also been criticized for putting their acquisitions into debt in order to pay themselves dividends. Upon acquisition of a new business platform (perhaps composed of multiple business units) the private equity firm has paid a substantial premium for an option on a portfolio. After separating it into multiple options on different business units, the private equity firm might understandable want to sell assets that don’t need to be owned (but could be leased instead), thereby reducing their equity investment and bringing the options closer to the money. Then additional borrowing (and withdrawal of dividends) again bring the options closer to the money. In order to illustrate the nuances of private equity as real options, we include discussion of three recent cases, each illustrating one of the common paths followed in private equity.
2008-02-21 22:37:54
Using Omega Measure for Performance Assessment of a Real Options Portfolio Castro Javier - RO - 2008 - english.pdf Strategy Castro Javier Ph. D. student The portfolio composition of assets is a classic theme in finance literature. Investors want to get highest return, minimizing as possible the involved risk. In a portfolio composed by real assets, such as investment projects, it must be decided which of them carry on. So, it is always a challenge to measure the involved risk. Furthermore, in a portfolio of real assets it’s possible to introduce and model for each individual project future investment decisions, like the right time to invest, making an expansion, reduction of operations, abandonment, etc. Bearing in mind the possibility of exercising these options, the model becomes more realistic. For this type of portfolios, in order to do an adequate assessment of their risk-return performance, it is proposed to use the universal measure called Omega, developed by Keating and Shadwick (2002), which reflects all the properties statistics of the distribution of gains and losses, incorporating all moments of the distribution of returns, and not only the mean and variance as is done in the classical approach of portfolio composition in Markowitz (1952). It’s demonstrated that using Omega measure for performance assessment and portfolio composition, is more advantageous than using the classic Mean-Variance approach. The main objective of our research is to apply the Omega measure in portfolios containing Real Options in their Investment Projects. Keywords: Portfolio, Real Options, Risk, Return, Omega Measure.
2008-02-21 23:01:00
Real Options under Fast Mean Reversion Stochastic Volatility Zubelli Jorge P. - realoptionabstract.pdf Computational Zubelli Jorge P. IMPA In this paper, we study the McDonald-Siegel (MS) model for real options under the assumption that the spanning asset undergoes a stochastic volatility dynamics that reverts to a historical value according to an Ornstein-Ullenbeck process driven by a second source of uncertainty. In this case, the market is not complete, and valuation, even for a perfectly correlated asset, is not as straightforward as in the MS model. Nevertheless, it is possible to derive a pricing equation by risk-neutral arguments that depends on the so-called market risk premium. Under the further assumption that the driving volatility process is fast-mean reverting, we derive an asymptotic approximation for the value of a real-option. In such case, the model becomes very parsimonious and can be calibrated to real data.
2008-02-21 23:33:31
A Framework for Valuing, Optimizing and Understanding Managerial Flexibility Dumont Charles - 20080220 - Valuing - Managerial - Flexibility.pdf Case Dumont Charles McKinsey and Company charles As NPV and Stochastic type analysis become more commoditized in the industry, many stakeholders are becoming increasingly aware and interested in the added value of managerial flexibility and options contained in projects. Based on a real project example this paper attempts to bring real options into the mainstream by providing a 3-step framework to be used by management and valuation teams to i) determine the risk factors and possible operational states of the project, ii) identify the real-options contained in each state of the project life cycle and iii) use genetic programming to optimize the valuation and understand the underlying value of each option. To illustrate the framework, the case of a company investigating the development of an oil sands project is used. A graphical state space map (influence diagram) is created along with defined business constraints and genetic programming is used to optimize the representation with the objective of maximizing the value of the project under stochastically generated scenarios. Moreover the genetic programming approach allows for a thorough exploration of the embedded options by computing the value of each option, the optimal decision thresholds and highlighting overlooked value creating optionality. In our case example applying this real option framework increased the expected value of the project by 50%, more than doubling the increased value of previously used ad hoc real option approaches.
2008-02-21 23:39:27
A Tutorial: An Intuitive Real Options Approach from Boeing --- Computational Mathews Scott The Boeing Company Tutorial Proposal: An Intuitive Real Options Approach from Boeing Scott H. Mathews, Assoc. Technical Fellow Computational Finance and Stochastic Modeling Phantom Works, Research and Development The Boeing Company Seattle, WA 206-766-3962 Central message of my tutorial. What is new, useful, and important about my message idea? Boeing has developed a set of strategic decision-modeling methods and tools, based on techniques used in options trading in the capital markets. These methods and tools appropriately value investment and risk of opportunities while assessing the likelihood of future events. Options applied to corporate strategic decision-making are termed "real options" because the target is an investment in a real asset (such as a technology or product), as opposed to an investment in a financial asset (such as an equity or bond). The field of real options has shown great promise since its advent about a decade ago. The field has, however, been slow to develop because of the complexity of the techniques that have been borrowed from the capital markets and the resultant mismatch to the needs and realities of corporate strategic decisions. Boeing has resolved these real option application difficulties through the development of state-of-the-art methods and tools. Boeing’s intuitive and transparent real option technology facilitates strategic planning, and aids decision makers in designing strategies that select high-benefit outcomes while minimizing risks. The method is easily integrated into spreadsheets using off-the-shelf simulation software extending net present value (NPV) analysis to incorporate risk and timing of decisions. When combined with systems engineering applications, it is termed “business engineering,” the application of risk-based financial modeling to engineering risk management and investments. This is particularly relevant in the new innovation economy in which the traditional NPV method does not provide proper information to the decision makers. The simplicity of the approach makes it likely that the Boeing method will become widely used as an important part of a decision making tool kit. What information/knowledge/ideas will the audience come away with? The audience will understand how a simple extension of the traditional NPV analysis can be applied to calculating the real option value of a project. We demonstrate that the option value actually emerges from a NPV analysis which has been developed with a straightforward inclusion of project scenarios and decision timing. We then show the real option calculation in a product engineering simulation which incorporates a stochastic market demand curve, dozens of engineering performance and cost variable uncertainties, and a production profile that also has uncertainties. There are at least six central ideas the audience will learn: 1) Our approach is intuitive and transparent. It can be easily explained to non-specialists. It can easily be taught to university students without complex mathematics. 2) The process directly uses information that’s widely used for NPV valuation by project analysts. 3) The method can be easily used within a spreadsheet using off-the-shelf simulation software. It is readily taught to business analysts. 4) Our method effectively incorporates risk by examining strategically a set of possible scenario outcomes that can be attributed to differing market conditions and cost assumptions. 5) The method provides a better perspective on strategies to hedge risk, capture upside opportunities, and will result in better project management. We term this ‘real option thinking.’ One typical use of our method will be demonstrated. The completely worked example centers on a funding decision for research and development prior to product launch. The teaching approach will be to contrast an NPV analysis, with a simple extension using simulation to derive the real option value, and show the resulting strategy implications. End of Proposal ************************************************** Who is the audience for my presentation? In our experience many decision makers, project managers and business analysts particularly those engaged in strategic business development are looking for a more intuitive and transparent way to value corporate investment decisions given cost and market uncertainty. They are the target audience. They will find this method easy to explain to their executive level decision makers. The material is supported by research and applications at Boeing Boeing has long conducted research in the field of real options, and is considered an industry leader (documented by a careful, year-long study by the U.S. Government Department of Energy). The research has been shared jointly among several universities, including Stanford University, University of Washington, and Seattle University. The result is a unique approach to valuing real options, termed the Datar-Mathews Method, which is more intuitive and transparent than other option valuation methods. Boeing is a manifestly obvious environment for real option innovation. Its multibillion dollars projects span years and involve significant technology and market risks. In the past several years, Boeing has begun to apply its real option techniques to actual programs. The result has been a more rigorous and better informed level of strategic thinking than provided by conventional financial tools. Real options can exposes weaknesses in business strategy, and provide a more agile response to changing technology and market conditions. Recently Boeing has begun to share this technology with others. The Boeing method has been published in the Journal of Applied Finance (Spring/Summer 2004), the Journal of Applied Corporate Finance (Spring 2007), and the INFORMS Tutorial (2008). I am frequently called upon to give presentations at conference, seminars within industry, at universities and to the U.S. government audiences. I was session chair for a real options topic at the INFORMS Pittsburgh conference, and gave an invited tutorial at INFORMS Seattle conference. Brief biography providing academic and professional foundation for the source of my authority. Scott Mathews is a Boeing Associate Technical Fellow, and the technical lead for the Computational Finance and Stochastic Modeling team for the Modeling and Simulation section within the Boeing research and development division. He has academic training in computer engineering, digital control systems, artificial intelligence computer science, and computational finance to go along with more than 20 years experience in the United States, Europe, and Asia as an engineer in robotic control systems, artificial intelligence, and systems and software development. Scott also has a decade of experience in stochastic modeling, capital markets investment and financial analysis, and international strategic analysis. At Boeing he leads a group of mathematical engineers responsible for developing investment and risk models for new products and strategically significant projects. He has expertise in complex financial and investment decision modeling that features real option pricing, and has a number of patents pending in the field. Scott holds a BSEE from Cornell University and an MS in Finance from Seattle University.
42 2008-02-21 23:44:42 OPTION VALUE IN PRESALE OF REAL ESTATE PROPERTY Brandao Luiz - Real Estate Brazil V1.pdf Case Brandao Luiz PUC-Rio A common practice in real estate markets is the sale of housing development units before completion, and in some cases even before beginning of the actual construction, known as presale. Developers that choose to presell units are subject to default on the part of the buyers if market conditions become unfavorable. In recent years, court rulings in Brazil have established that developers must refund 70% to 90% of payments made if the buyer chooses to opt out of the sales contract. This configures an abandon option for the buyer and creates a contingent liability for the real estate developer. We determine the value of the option to abandon in the Brazilian real estate market and model this flexibility to opt out of the sales contract as an American type option. Our results indicate that the option value is substantial and can have important impacts on the profitability and exposure to risk of the real estate developer with potential consequences to the Brazilian real estate market.
2008-02-22 02:00:38
Tax Effects on Timing, Scale, and Learning Options in Petroleum Upstream Dias Marco A. G. - extended - abstract - dias - tax effects - on - oil - ro.pdf Resources Dias Marco A. G. PUC-Rio, Dept. of Industrial Engineering The escalation of oil prices in the last years has motivated a debate about natural resources taxation. This paper uses real options approach to discuss different taxation devices for exploration & production (E&P) with focus in Brazilian petroleum sector. The concept of tax neutrality under uncertainty is established when both the project value and investment follows correlated stochastic processes, analyzing the option to delay a project considering corporate income tax and royalties. Other issues like tax efficiency, risk exposition and simplicity, are also considered. The paper discusses the taxation effect on optimal investment timing when exists discrete mutually exclusive alternatives to develop an oilfield, that is, consider the scale option issue on taxation. Next, the paper analyzes the special participation tax for high productive oilfields when there is technical uncertainty about the size and quality of the oilfield considering the learning option before developing the field. The paper suggests a more efficient and win-win design for this special participation tax.
2008-02-22 17:01:53
Real Options and Facilities Access Regulation Sick Gordon - ROAndRegulationPaper.pdf Infrastructure Sick Gordon University of Calgary Real options achieve their value from flexible management response to signals about uncertainty. Any constraint on flexibility will obviously impair the real option value. Regulation imposes constraints on operations, but also provides tariffs to the regulated entity. Thus, it is not obvious that the regulated entity necessarily suffers a value loss from regulation, if the tariffs are excessively generous. The question of whether the tariffs are excessively generous is a question of social optimality. We address this question in the context of facilities access, which is a popular method of ``deregulating'' industries that had monopoly power. The regulator determines tariffs for access to the production facilities of the oligopolist facility owner so that competitors can use the facilities and offer the consumption good in a competitive market. This is the basis for deregulation of power, gas distribution and telecom industries. It has also been proposed in industries that were not formerly regulated, such as the rail infrastructure for integrated mining industries. Pindyck has suggested that access tariffs in these cases should include compensation for the capital costs plus the real option premium that was extinguished to establish the facility. But he offers no proof, nor any analysis of the magnitude and direction of the distortion if compensation is only offered for the capital costs only. Also, he does not consider two-part tariff structure with an up-front access tariff, plus an annual tariff for capacity. In this paper, we investigate these issues numerically.
2008-02-26 09:57:32
Real options: application on a viability study of a new project in the real estate sector. Dos Reis Sergio Maurvcio - ARTIGO EM INGLKS 26 02 2008.pdf Strategy Dos Reis Sergio Maurício Fead Nucléo de Pós-Graduação e Pesquisa This article deals with the usage of the real options method as a tool for aiding the economic-financial analysis of a new venture in a real state company, based on a case-study. Studies of new ventures were selected in Minas Gerais, São Paulo and Brasília, totalling 14 ventures presented in the second semester of 2006. The sample is an intentionally selected viability study of a new venture. The work sought to establish a comparison between the results obtained through traditional financial indices, resulting from an idealized Cash Flow project, and the possible results obtained from this project real options model. The research was also used to build, within the real options model, the alternative of abandoning the project, including all of the calculations and analyses which are inherent to the matter. Since this is a viability study of a new venture, there was no literature available that could help to determine the project volatility, which is an important variable for calculating the real option. The results of this work lead to the conclusion that the methodology can be applied to similar viability studies, since it brought a new perspective for decision-making. Based on what has been said, the conclusion that was reached is that the study offers arguments and information that allow for better decision-making regarding the approval or not of a new venture feasibility study. It also provides useful parameters for defining the best moment to execute the option of abandoning the project, in case this is the developer’s decision. Key words: Real options method; economic-financial method; abandonment option.
2008-02-27 08:12:31
EVALUATION OF THE CONVERSION OPTION OF BIODIESEL VERSUS SOYA OIL IN A SOYA PROCESSING PLANT Berni Murilo - NEW - Trans artigo Murilo JA HB 20 Feb 2008 HGB.doc Case Berni Murilo FEAD Minas The object of the present dissertation is to evaluate economically-financially the project for agro-industrial investment in the light of the Real Options Theory. The traditional methods of evaluation, such as the NPV (Net Present Value) of the projected cash flows, reveal themselves limited when utilized in the analysis of projects related to products with high levels of volatility and/or projects that possess important managerial flexibilities. In this sense, the Real Options Theory seeks to complement the traditional analyses, incorporating in these the value of the flexibilities embedded in the investment projects. The following study considers the value of the conversion option in the agro-industrial project referred to, which consists of the establishment of a soya processing plant with flexibility for the production of vegetable oil, or biodiesel. The tools proposed by the Binomial and Quadrinomial models were used for this purpose. The application of these models allows for the addition to the traditional project NPV, of the value of the managerial flexibility relative to the decision whether to produce soya oil or biodiesel, such decision being very important when dealing with products that possess distinct behaviour and price levels. In this sense, the choice of the product that proportions the best return is an option available to the manager, which possesses value and which, therefore, should be considered in the analysis of this investment. In harmony with the proposal of the Real Options Model, the conversion option, or, in other words, the managerial flexibility intrinsic to the project, raises the value of the undertaking under study.
2008-02-29 09:03:43
A Real Option Method Application in an Investment Project of the Higher Private Teaching Institution  Paganella Ibanks - NEW - Artigo Ibanes JA HB English 2008.doc Case Paganella Ibanês FEAD Minas This study checks the applicability of the method of real options as an effective tool to help in the analysis model of traditional investments in higher teaching institutions, from the perspective of improvements in decision-taking. The research uses cash flow, consolidated management and accounting reports of all the courses of one such selected institution, over the period 2005 to 2006. As an auxiliary tool, the software @Risk® was used to find the volatility of the Net Present Value, as well as its most probable value, through the Monte Carlo simulation technique, demonstrating possible results of the risk measurement. For collection of data essential to the research, information was gained based on the cash flow used as the control, in the daily management of the company, containing principally: gross income, direct taxes, net income and all costs contained in the institution’s cash flow and management and accounting reports. As the result of this work, it is concluded that the theory of real options serves the needs of the institution and can be applied in practice, as it is the flexible model and the strategic indicator.
2008-03-03 14:38:28
Love, Death and Taxes: Applications of Real Options "in" Economic Systems von Helfenstein S.B. - Love, Death and Taxes - Applications of Real Options in Economic Systems.pdf Valuation von Helfenstein S.B. Braver PC Abstract: Love, death and taxes – these are the inevitable, yet uncertain and risky, events of which life cycles and systems are composed. While we normally think of them in terms of human life cycles, they can be applied to economic life cycles as well, under different names. The description and quantification of love, death and taxes in human life are under the purview of the social scientists, statisticians, actuaries, and poets. But the description and quantification of these in economic systems remains the task of economists, finance and valuation professionals. As economic systems become increasingly more complex and dynamic and the universal language of historical accounting is being altered, the theory and tools we use in economics, finance, and valuation are beginning to prove inadequate to the tasks being required of them. Hence, there is a need to consider new avenues of thought and new tools. In this paper, we explore the potential use of real options “in” systems design as a means to achieve more rigorous and insightful results in the design and valuation of the economic system of the firm.
2008-02-21 00:00:00
To wait or not to wait: When do announced Initial Public Offerings are
Sodjahin William - IPO Real Option 2008.pdf Valuation / Empirical Sodjahin William Université Laval This paper proposes a model that formalizes the optimal external timing for an initial
public offering using real options concept and also presents empirical analysis. It is the
first study to investigate the factors influencing the IPO waiting period. We find strong
evidence of information production by waiting period. In line with the predictions of our
model, the waiting period is more likely to be longer the larger syndicate size. We argue
that the high competition risk among syndicate members (Corwin and Schultz, 2005) for
larger syndicate size sets back the completion of the IPO. We provide evidence that the
waiting period is also strongly related to leverage, investment and managerial incentives.
Controlling for other potential determinants, we show that the probability of switching
syndicate size in subsequent SEOs is strongly related to waiting periods and underwriter
switches. We finally show that the longer the SEO waiting period the better the first-day
market reaction on subsequent SEO date given that longer waiting periods are associated
with less adverse selection risk.
2008-02-28 00:00:00
Evaluating the Expansion Flexibility of Manufacturing Systems in Uncertain Environments Pellegrino Roberta - ExtendedAbstract - RO2008 - Pellegrino.doc Valuation / Computation Pellegrino Roberta Politecnico di Bari Today having the agility to react to changes in market conditions is one of the keys to success in dynamic and uncertain manufacturing environments.
Manufacturing flexibility is an important part of a firm’s competitive strength. Flexibility of a system can be defined as “its adaptability to a wide range of possible environments that it may encounter. A flexible system must be capable of changing in order to deal with a changing environment.” (Sethi and Sethi, 1990). Flexibility in manufacturing systems can be of different types: machine, material handling, operation, process, product, routing, volume, expansion, program, production, and market flexibility. Acquiring this flexibility has a cost. In fact, the investment in flexible manufacturing equipment is generally major than the investment in dedicated equipment. But, on the other hand, a flexible system allows managers to cope with uncertainty and to do future actions in response to market changes. “Flexibility gives the management some degrees of freedom to take advantage of outcomes better than expected and simultaneously provide an ability to reduce losses” (Bengtsson, 2001). This is often very valuable for the firm. The problem is: how valuable is this flexibility? How much money is a firm disposed to spend in order to have this flexibility? To answer these questions, an appropriate methodology able to take into account these characteristics has to be used. Traditional techniques, in fact, are not suitable for evaluating such kinds of flexible manufacturing system investments. They assume that management makes an irrevocable decision on the basis of its future market expectations. Therefore, they assume that the “deterministic” cash flows are known with certainty at initial time. Then, they are discounted with a given discount rate (discounted cash flow – DCF – methodology). This is enough correct in absence of uncertainty, but when managers have the possibility to change their initial decision for reacting to new information from market and, therefore, to improve the value of the project, traditional discounted cash flow methodology assumptions are too heavy.
Thus, other more suitable methods to value this flexibility have been proposed in literature; some are based on real options, others do not directly use options theory (Kulatilaka, 1988; Kumar, 1995; He and Pindyck, 1989; Karsak and Ozogul, 2005; Trigeorgis, 1996).
In the present paper the author focuses on one kind of manufacturing flexibility: the expansion flexibility. “Expansion flexibility of a manufacturing system is the ease with which its capacity and capability can be increased when needed” (Sethi and Sethi, 1990). This kind of investment can be viewed as consisting of two investment phases (Kumar, 1995). The first (“primary investment”) is the initial price paid to acquire flexible system. The second (“secondary investment”) represents the additional investment required at a later date in order to use flexibility provided by the system. This investment will be made if there are the market conditions (that require the capacity increase) and if it is convenient. As Sethi and Sethi (1990) state, expansion flexibility can be achieved in several ways, such as, for example, by having modular manufacturing system, building small production units, acquiring multipurpose machinery, having a high level of automation that can facilitate mounting additional shifts, providing infrastructure to support growth. From a real options perspective, the initial investment to acquire this option (that is, the investment needed to have flexible system) corresponds to the option price or premium, while the secondary investment to make for expanding the system capacity is the strike or exercise price. As said above, capital expenditure required for flexible system are generally higher than dedicated production systems, and the potential future costs and benefits - that could result from exercising the option - are difficult to value with accuracy at initial time. This is particularly true in presence of a high level of uncertainty, when it is difficult to foresee if the option will be exercised or not.
For this reason, this kind of investments requires a correct evaluation tool. The possible secondary investment (for the capacity increase) and the resulting benefits have to be taken into account during the evaluation of the initial investment (that is, when managers have to decide if to invest or not and choose among investment alternatives). Approaches based on option theory have been developed in order to do this (Kumar, 1995; Karsak and Ozogul, 2005).
In this paper, the author adopts an approach based on Monte Carlo method (already tested in another – more simple – production context (Costantino and Pellegrino, 2007)). Unlike the traditional techniques, Monte Carlo simulation is able to take several different (theoretically endless) uncertainty sources into account in the evaluation. It assigns a probability distribution (derived by the managers’ experience) to each uncertain or variable model input. On the contrary of traditional methodologies, this can give a (probabilistic) result also when the system complexity does not have closed-form solutions. The traditional techniques proposed in literature for valuating real options have their roots in financial world, such as Black-Scholes’ (1973) model modifies by Merton in 1973, Boyle’s (1977) model for European options, binomial model presented by Cox, Ross and Rubinstein (1979), Least Squares Monte Carlo approach (LSM) proposed by Longstaff and Schwartz (2001), and others. The “financial origin” of these methods often limits their application in real world cases (Lander and Pinches, 1998), especially when the uncertainty sources increase. In fact, they assume that only one (or, however, few) parameter is affected by uncertainty, the others are generally deterministic.
This paper presents a quantitative model based on Monte Carlo technique in order to value the option of capacity expansion. Managers have to decide at initial time if to invest in a flexible manufacturing system (with the possibility to increase capacity in the future) or in dedicated system. In other words, the firm has to value if it is convenient to spend additional money to acquire expansion flexibility. Managers have foreseen that an increase of the current demand for final product could happen with a certain probability. Thus, the developed model considers if this event happens. In a positive case, it values if it is really convenient to expand production capacity according to the actual production costs and selling price. In other terms, the model values if the benefits resulting from the capacity expansion (that is, the exercise of the option) are major than the costs to do this.
The input parameters of the model are described with adequate probability distributions (on the basis of the managers’ expectations), such as the probability that a demand increase happens, or the value of this increase. Then, the differential benefits and costs between a flexible system and a dedicated one are considered. An illustrative case shows the model working and its results by using the Crystal Ball software. With enough repetitions, it is possible to obtain a probability distribution of benefits/costs associated to this expansion option. This way, managers can assess the probability to have a positive result and the extent of probabilistic differential benefits against an initial certain expenditure for acquiring this flexibility. This tool could be an interesting guide for managers in order to value this kind of investment in uncertain environments. It is clear that the value of this option increases with increasing uncertainty, and it has no value when there is no uncertainty.