scholarly journals Assessing the Option to Abandon an Investment Project by the Binomial Options Pricing Model

2016 ◽  
Vol 2016 ◽  
pp. 1-12 ◽  
Author(s):  
Salvador Cruz Rambaud ◽  
Ana María Sánchez Pérez
Keyword(s):  
Real Option ◽  
Net Present Value ◽  
Investment Project ◽  
Mathematical Expression ◽  
Options Pricing ◽  
Pricing Model ◽  
Operational Flexibility ◽  
Present Value ◽  
Project Appraisal ◽  
Financial Options

Usually, traditional methods for investment project appraisal such as the net present value (hereinafter NPV) do not incorporate in their values the operational flexibility offered by including a real option included in the project. In this paper, real options, and more specifically the option to abandon, are analysed as a complement to cash flow sequence which quantifies the project. In this way, by considering the existing analogy with financial options, a mathematical expression is derived by using the binomial options pricing model. This methodology provides the value of the option to abandon the project within one, two, and in general n periods. Therefore, this paper aims to be a useful tool in determining the value of the option to abandon according to its residual value, thus making easier the control of the uncertainty element within the project.

scholarly journals The Valuation of the Operational Flexibility of the Energy Investment Project Based on a Gas-Fired Power Plant

Energies ◽  
2020 ◽  
Vol 13 (7) ◽  
pp. 1567 ◽  
Author(s):  
Dominik Kryzia ◽  
Michał Kopacz ◽  
Katarzyna Kryzia
Keyword(s):  
Monte Carlo ◽  
Net Present Value ◽  
Investment Project ◽  
Combined Cycle ◽  
Operational Flexibility ◽  
Present Value ◽  
Discounted Cash Flow ◽  
Energy Investment ◽  
Significance Level ◽  
Technical Parameters

This paper presents an attempt to the valuation of the operational flexibility of the energy investment project based on the example of combined cycle gas turbine (CCGT). For this purpose, the real options approach (ROA), net present value (NPV) method, and the Monte Carlo (MC) simulation have been used. Motivations to take up such a topic result from the fact that traditional valuation methods neglect flexibility embedded in CCGT assets. Operational flexibility was defined as the switching option to dynamically shut down and restart gas units. Valuation of the operational flexibility, the project’s extended net present value (XNPV), was based on a discounted cash flow model. The Monte Carlo simulation, allowing for better replication of the stochastic nature of market factors and some technical parameters, was introduced to the valuation model. The obtained results indicate that the value of the options significantly influences the NPV of the analyzed technology and its risk profile. The NPV was calculated at −169.1 million USD, while the XNPV amounted to 102.5 million USD. This difference, compared to the NPV distribution range at a significance level of 0.05, was more than 8.1% (almost 10.4% for α = 0.1). The results achieved help to explain the significance of the operational flexibility in the modeling profitability of CCGT technologies.

The modified binomial options pricing model and the revised replicating portfolio approach with the concept of sustainability options

2020 ◽  
Vol 07 (02) ◽  
pp. 2050013
Author(s):  
Tyrone T. Lin ◽  
Hui-Tzu Yen ◽  
Shu-Yen Hsu
Keyword(s):  
Net Present Value ◽  
Evaluation Criteria ◽  
Options Pricing ◽  
Pricing Model ◽  
Objective Functions ◽  
Present Value ◽  
Project Investment ◽  
Decision Variables ◽  
Portfolio Approach ◽  
Replicating Portfolio

This paper discusses whether the project investment can develop the decision-making for the concept of sustainability options. The conventional net present value (NPV) approach assesses whether the project investment should be implemented, and develops the evaluation criteria of implementing sustainability costs from the modified binomial options pricing model (BOPM) and the revised replicating portfolio approach. It treats options premium value and the replicating portfolio approach (RPA) value as the objective functions, and the options premium of the BOPM and the initial values of the RPA as the decision variables.

scholarly journals Decision Making for Project Appraisal in Uncertain Environments: A Fuzzy-Possibilistic Approach of the Expanded NPV Method

Symmetry ◽  
2020 ◽  
Vol 13 (1) ◽  
pp. 27
Author(s):  
Konstantinos A. Chrysafis ◽  
Basil K. Papadopoulos
Keyword(s):  
Net Present Value ◽  
Fuzzy Numbers ◽  
Cost Of Capital ◽  
Weighted Average ◽  
Present Value ◽  
Major Drawback ◽  
Project Appraisal ◽  
Equity Cost ◽  
Set Up ◽  
Intelligent Methods

The major drawback of the classic approaches for project appraisal is the lack of the possibility to handle change requests during the project’s life cycle. This fact incorporates the concept of uncertainty in the estimation of this investment’s worth. To resolve this issue, the authors use fuzzy numbers, possibilistic moments of fuzzy numbers and the hybrid (fuzzy statistic) fuzzy estimators’ method in order to introduce a fuzzy possibilistic version of the expanded net present value method (FPeNPV). This approach consists of two factors: the fuzzy possibilistic NPV and the fuzzy option premium. For the estimation of the fuzzy NPV, some basic assumptions are taken into consideration: (1) the opportunity cost of capital, used as the present value interest factor calculated through the weighted average cost of capital (WACC), (2) the equity cost, determined through the possibilistic set-up of the capital asset pricing model CAPM, and (3) the inflation factor, also included in the estimation of the NPV. The fuzzy estimators’ method is used for the computation of the fuzzy option premium. An algorithm of nine major steps leads to the computation of the FPeNPV. This gives the administration the opportunity to adapt to potential changes in the company’s internal and external environments. In this way, the symmetry between the planning and execution phase of a project can be reinstated. The results validate the statement that fuzzy and intelligent methods remain valuable tools to express uncertainty in various scientific areas. Finally, an illustrative example aims at a thorough comprehension of this new approach of the expanded NPV method.

Real Option Methodology for the Evaluation of IT Projects

2007 ◽  
Vol 8 (1) ◽  
pp. 71-88
Author(s):  
Efthymios Papadopoulos ◽  
Georgios Dounias
Keyword(s):  
Real Option ◽  
Net Present Value ◽  
New Technology ◽  
Full Range ◽  
Present Value ◽  
It Projects ◽  
Innovative Strategy ◽  
Technology Deployment ◽  
Project Valuation ◽  
Project Risks

Current project valuation framework under the Net Present Value (NPV) method has been proved to be incomplete, as it fails to accurately account for uncertainty. Traditional financial tools fail because they neglect to account for the value of flexibility. The standard NPV approach assumes that project risks remain constant over the life of the strategy. It, also, fails to factor in the full range of opportunities that a new and innovative strategy may create for a firm in the future. We show how one can use Real Option methodology in order to determine optimal financial path to fund new technology deployment within a risky environment. Moreover, in this paper we demonstrate, with the use of a simple numerical example, how the Real Options methodology can be implemented within an IT project deployment.

Value-Creating Investment Strategies to Manage Risk From Structural Market Uncertainties: Switching and Compound Options in (V)HTR Technologies

2008 ◽  
Author(s):  
Ulrike La¨uferts ◽  
Charlotte Halbe ◽  
Aliki van Heek
Keyword(s):  
Cash Flow ◽  
Discount Rate ◽  
Real Option ◽  
Net Present Value ◽  
Energy Markets ◽  
Present Value ◽  
Technology Investment ◽  
Compound Options ◽  
Managerial Flexibility ◽  
Strategic Value

To measure the value of a technology investment under uncertainty with standard techniques like net present value (NPV) or return on investment (ROI) will often uncover the difficulty to present convincing business case. Projected cash flows are inefficient or the discount rate chosen to compensate for the risk is so high, that it is disagreeable to the investor’s requirements. Decision making and feasibility studies have to look beyond traditional analysis to reveal the strategic value of a technology investment. Here, a Real Option Analysis (ROA) offers a powerful alternative to standard discounted cash-flow (DCF) methodology by risk-adjusting the cash flow along the decision path rather than risk adjusting the discount rate. Within the GEN IV initiative attention is brought not only towards better sustainability, but also to broader industrial application and improved financing. Especially the HTR design is full of strategic optionalities: The high temperature output facilitates penetration into other non-electricity energy markets like industrial process heat applications and the hydrogen market. The flexibility to switch output in markets with multi-source uncertainties reduces downside risk and creates an additional value of over 50% with regard to the Net Present Value without flexibility. The supplement value of deploying a modular (V)HTR design adds over 100% to the project value using real option evaluation tools. Focus of this paper was to quantify the strategic value that comes along a) with the modular design; a design that offers managerial flexibility adapting a step-by-step investment strategy to the actual market demand and b) with the option to switch between two modes of operation, namely electricity and hydrogen production. We will demonstrate that the effect of uncertain electricity prices can be dampened down with a modular HTR design. By using a real option approach, we view the project as a series of compound options — each option depending on the exercise of those that preceded it. At each end of the design phase, the viability will be reviewed conditional on the operating spread at each time step. We quantify the value of being able to wait with the investment into a next block until market conditions are favourable and to be able to abandon one block if market conditions are disapproving. To derive the intrinsic value of this multi block HTR design, it will be compared with a reference investment of a full commitment light water reactor without any managerial flexibility. In another case, we raise the question to what extent product output diversification is a suitable strategy to cope with long term market uncertainty in electricity price. What is the value of a multi-potent technology that is able to produce output for energy markets others than the electricity market? To investigate this, we concentrate on The Netherlands, a country with an intense industrial demand in electricity and hydrogen.

scholarly journals EFFICIENCY ASSESSMENT OF IMPLEMENTATION OF THE MECHANISM OF INNOVATIVE RISK MANAGEMENT OF THE FAT AND OIL INDUSTRY IN UKRAINE

ScienceRise ◽  
2020 ◽  
pp. 61-70
Author(s):  
Yuliya Zhadan
Keyword(s):  
Risk Management ◽  
Net Present Value ◽  
Methodological Approach ◽  
Oil Industry ◽  
Pricing Model ◽  
Present Value ◽  
Efficiency Assessment ◽  
Before And After ◽  
Capm Model

Object of research: risk management processes of enterprises of the oil and fat industry in Ukraine. Investigated problem: to assess the efficiency of the implementation of the mechanism of innovative risk management for enterprises of the oil and fat industry in Ukraine Main scientific results: the paper proposes a scientific and methodological approach to quantifying the effectiveness of the implementation of the mechanism of innovative risk management (MIRM) of enterprises of the oil and fat industry in Ukraine, based on comparing the net present value before and after the MIRM implementation and consists of a number of successive interrelated stages, which include: comparative analysis and integrated assessment of unsystematic (financial, production, investment and other types) risks before and after the MIRM implementation at the enterprise; expert assessment of systematic risks that form the environment of the enterprise and can’t be controlled; determination of the total risk value as an arithmetic weighted average non-systematic and systematic component for each type of risk; determination of discount rates taking into account risk before and after the MIRM implementation at the enterprise using the CAPM model (capital assets pricing model) for calculating and comparing the net present value before and after the MIRM implementation at the enterprise (NPV and NPV', respectively). Efficiency assessment of the implementation of the mechanism of innovative risk management (MIRM) was carried out on the example of eleven processing enterprises of the fat and oil industry in Ukraine. The scope of practical use of research results: the risk management system of processing enterprises of the fat and oil industry in Ukraine, which should be the object of constant monitoring of the feasibility of implementation and assessment of the effectiveness of MIRM functioning by management and top management. Innovative technological product: a scientific and methodological approach to quantifying the effectiveness of the implementation of the mechanism of innovative risk management for enterprises of the oil and fat industry in Ukraine, based on comparing the net present value before and after the MIRM implementation (NPV and NPV’, respectively) using the CAPM model (capital assets pricing model) to determine the discount rates taking into account the risk before and after the MIRM implementation (d and d', respectively), which makes it possible to determine the expected amount of reduction in losses at the processing enterprises of the oil and fat industry of Ukraine from the implementation of a set of risk management measures and make informed management decisions on the appropriateness of their application. Scope of application of the innovative technological product: processing enterprises of the oil and fat industry in Ukraine.

scholarly journals The Sunk Cost and the Real Option Pricing Model

Complexity ◽  
2021 ◽  
Vol 2021 ◽  
pp. 1-12 ◽  
Author(s):  
Songsong Li ◽  
Yinglong Zhang ◽  
Xuefeng Wang
Keyword(s):  
Option Pricing ◽  
Real Options ◽  
Real Option ◽  
Value Function ◽  
Intrinsic Value ◽  
Pricing Model ◽  
Sunk Cost ◽  
Financial Options ◽  
Real Option Pricing ◽  
Option Pricing Model

Although the academic literature on real options has grown enormously over the past three decades, hitherto an accurate real option pricing model has not been developed for investment decision analyses. In this paper, we propose a real option pricing model based on sunk cost characteristics, which can estimate the value of real options more accurately. First, we explore the distinctive features that distinguish real options from financial options. The study shows that the distinguishing feature of the real options is the sunk cost, which does not exist in the financial options. Based on the sunk cost characteristic of real options, we find that the exercise conditions of real and financial options are different. Second, we introduce the sunk cost into the intrinsic value function of real options and establish a new real option pricing model. Finally, this paper also discusses the properties of the intrinsic value function and pricing model of real options. We find that the application of the Black–Scholes option pricing model will overestimate the value of real options.

scholarly journals A Real Options Approach to Valuate Solar Energy Investment with Public Authority Incentives: The Italian Case

Energies ◽  
2020 ◽  
Vol 13 (16) ◽  
pp. 4181
Author(s):  
Antonio Di Bari
Keyword(s):  
Solar Energy ◽  
Real Options ◽  
Real Option ◽  
Net Present Value ◽  
Option Value ◽  
Present Value ◽  
Energy Investment ◽  
The Real ◽  
Real Options Approach ◽  
Real Option Value

Solar energy investment represents currently a valid reason to support sustainable economic development. In fact, over the last few years, governments have applied different measures to incentivize private consumers and firms to use renewable energies. Photovoltaic (PV) projects are characterized by uncertainty due to meteorological conditions, the unpredictable behavior of government, and managerial flexibility. Since the Net Present Value (NPV) approach is not able to capture these uncertain factors, it was replaced with the Real Options Approach (ROA). The latter method manages to embed flexibility in PV investment using binomial trees. This paper valuates PV investment in all regional areas in Italy using an integrated approach between the discounted cash flows method and real option value, called Expanded Net Present Value (ENPV). We fit the probability of tax benefits into a binomial lattice model after analyzing the geographical position and weather conditions of all regional capitals of Italy. The results show that the cities with high irradiance/temperature have positive NPV and high investment values. On the other hand, while most cities have negative NPV, the inclusion of the flexibility in investment decisions gives additional value to the project, making the ENPV positive and implying an attractive investment opportunity with the possibility of delaying the project. We also propose a sensitivity analysis that shows how the real option value changes when incentive policies of the government become more attractive. This paper contributes to the existing literature in the way of considering financial, meteorological/geographical, and political factors to valuate PV investment.

scholarly journals Efficiency of investing in the material and technology base of power willow production

2019 ◽  
pp. 181-186
Author(s):  
Gritsyshyn, M. ◽  
Perepelytsya, N.
Keyword(s):  
Net Present Value ◽  
Investment Project ◽  
Economic Indicator ◽  
Bioenergy Crops ◽  
Investment Efficiency ◽  
Present Value ◽  
Technical Base ◽  
Analysis And Synthesis ◽  
Technological Base ◽  
Specialized Equipment

Purpose. Substantiation of indicators of investment efficiency in the development of material and technical base of cultivating bioenergetic cultures on the basis of national samples of specialized equipment. Methods. Monographic, economic-mathematical, analysis and synthesis, abstract-logical, graph-analytical, system engineering. Results. An analysis of the investment attractiveness of the bioenergetic crop sector, implemented by the integrated financial and economic indicator of net present value, indicates the feasibility of increasing the capitalization of bioenergy crops production based on the latest domestic technology samples that will provide an increase in the net present value of the investment project for laying energy volts of energy willow by 30% in comparison with foreign analogues. Conclusions. The formation of the latest technical and technological base for the production of bioenergy crops requires significant investment and state protectionism. Creation of a favorable investment climate for the innovative development of material and technical base of production of bioenergy crops on the basis of domestic high technology technical level will ensure the dynamic development of not only bioenergy industry, but also the domestic economy as a whole. Keywords: bioenergy, technical and technological base, investment, economic efficiency.

Evaluation Method of Net Present Value of Investment Project taking into account the Influence of Environmental Factors

2019 ◽  
Vol 2019 (1) ◽  
pp. 139-156
Author(s):  
Denis Shageev
Keyword(s):  
Environmental Factors ◽  
Risk Premium ◽  
Evaluation Method ◽  
Swot Analysis ◽  
Net Present Value ◽  
Positive Impact ◽  
Investment Project ◽  
Present Value ◽  
Chi Square ◽  
A New Technique

In the complex and unpredictable environment of the XXI century, in advanced and emerging economies it is becoming increasingly important for investors to adopt new techniques that allows for the most accurate assessment of net present value (NPV) of an investment project through a risk premium or risk adjustment. The existing methods of risk assessment do not always meet the modern requirements of investors due to various limitations and shortcomings. Therefore, the article provides a new technique that allows to assess the NPV taking into account not only the negative but also the positive impact of environmental factors. Drawing on this technique, the authors propose to evaluate the influence of environmental factors using the triad of STEP-, SNW- and SWOT-analysis based on heuristic and expert technologies. It is proposed to check the agreement of the results of evaluation through the Chi-square criterion. The methodology further uses these estimates to calculate the risk premium and adjust the risk to determine the NPV.

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