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.

scholarly journals Real option analysis. The viability of real estate projects

2020 ◽  
Vol 17 (4) ◽  
pp. 271-284
Author(s):  
Alberto Munoz Cabanes ◽  
Alfonso Herrero de Egana ◽  
Arturo Romero
Keyword(s):  
Real Estate ◽  
Real Option ◽  
Net Present Value ◽  
Initial Conditions ◽  
Present Value ◽  
The Real ◽  
The Real Estate ◽  
Real Option Analysis ◽  
Project Valuation ◽  
Real Estate Project

Traditional methods used for real estate project valuation, such as the static Net Present Value, have some limitations, as these methods do not consider the possibility of a change in the initial conditions of the project or during its development. On the other hand, the real options approach allows for flexibility in evaluating a real estate project, improving the decision-making process as it helps identify the optimal strategy and timing for the construction phases. The paper deals with evaluating an actual real estate project in La Rioja (Spain) using different options to estimate its final Net Present Value. The results show that the real estate project would be profitable under several scenarios, although the valuations can vary significantly among the different types of options. This is because some options add more value to the project than others, depending on their cost and the uncertainty they eliminate. In contrast, the results obtained using the traditional static method would have led a real estate developer to discard the project completely, as its Net Present Value would have been negative. This confirms that the introduction of flexibility in real estate developments creates additional value by allowing developers and investors to dynamically react to changes in the market, thus making better investment decisions and finding real estate investment opportunities that otherwise would not be considered at all.

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 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.

CAUTIOUS ANALYSIS OF PROJECT RISKS BY INTERVAL-VALUED INITIAL DATA

2006 ◽  
Vol 14 (06) ◽  
pp. 663-685 ◽  
Author(s):  
LEV V. UTKIN
Keyword(s):  
Initial Data ◽  
Net Present Value ◽  
Cash Flows ◽  
Random Set ◽  
Present Value ◽  
Random Set Theory ◽  
Imprecise Dirichlet Model ◽  
Project Risks ◽  
Dirichlet Model ◽  
Interval Valued

One of the most common performance measures in selection and management of projects is the Net Present Value (NPV). In the paper, we study a case when initial data about the NPV parameters (cash flows and the discount rate) are represented in the form of intervals supplied by experts. A method for computing the NPV based on using random set theory is proposed and three conditions of independence of the parameters are taken into account. Moreover, the imprecise Dirichlet model for obtaining more cautious bounds for the NPV is considered. Numerical examples illustrate the proposed approach for computing the NPV.

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 COMPARATIVE ANALYSIS OF EVALUATION MODELS EFFECTIVENESS OF INVESTMENTS IN INNOVATION PROJECTS (PART 1)

2019 ◽  
pp. 99-110
Author(s):  
O. Zaitsev
Keyword(s):  
Capital Investment ◽  
Net Present Value ◽  
New Technology ◽  
Investment Efficiency ◽  
Capital Investments ◽  
Present Value ◽  
Advantages And Disadvantages ◽  
Efficiency Assessment ◽  
Reduced Costs ◽  
Further Development

The article describes the main models and methodological tools for evaluating the effectiveness of investment and innovation measures and mechanisms that have been developed and applied in the economic environment since the mid-twentieth century. The article discusses two directions in the assessment of investments: the direction of market evaluation of the introduction of innovation / investment and the direction of the assessment of the effectiveness of capital investment (investment) in the development of new technology (innovation), which was used in the conditions of non-market (planned) economic system. The article has characteristics about the advantages and disadvantages of both areas. The direction of further development of investment efficiency assessment models is outlined. Keywords: net present value, discounting, economic efficiency of capital investments, reduced costs, indicator of the speed of specific increment in value.

scholarly journals The Method of Real Options in the Evaluation of Strategic and Investment Decisions

2017 ◽  
Vol 5 (3) ◽  
pp. 41-45
Author(s):  
Гераськина ◽  
A. Geraskina
Keyword(s):  
Real Options ◽  
Real Option ◽  
Net Present Value ◽  
Option Price ◽  
Investment Decisions ◽  
Present Value ◽  
Discounted Cash Flow ◽  
Investment Projects ◽  
Important Addition ◽  
Discounted Cash Flow Method

The method of real options is one of the new approaches to estimate investment projects’ cost and it is an important addition to discounted cash flow method. Real option significantly increases the efficiency of the project due to the possibility of decision-making during its implementation. This aspect is especially important in unstable environmental conditions. The main differences between the financial and real options are presented. The differences of valuation of investment projects by the real options method and net present value are examined. The article presents the types of real options, as well as the methods of calculating the option price.

Small company economics–net present value versus net cash flow

2011 ◽  
Vol 51 (1) ◽  
pp. 369
Author(s):  
Michael Scott
Keyword(s):  
Cash Flow ◽  
Net Present Value ◽  
Small Company ◽  
Present Value ◽  
Term Survival ◽  
Oil Companies ◽  
Project Valuation ◽  
Company Directors ◽  
Exploration Drilling ◽  
Positive Cash Flow

This paper is primarily written for the benefit of the small company that survives hand-to-mouth on a day-to-day basis. Personnel working in large profitable oil companies that spin off lots of positive cash flow may have difficulty empathising with the example. Net present value is a commonly accepted method of project valuation. Globally, projects are valued, ranked, justified, bought and sold using this technique. For all companies, however, cash is considered to be king. Cash funds exploration activities and corporate costs and allows companies to continue trading without returning to shareholders for additional funds. Both the solvency of the company and the dilution of share value are extremely important considerations for company directors. For a small company with income being generated from a single small field, an example is presented where a simple decision is considered: keep the field and live off the annual income or sell the field and live off the declining balance. This is an extremely simple example used to demonstrate the power of cash flow. No alternative investment is available and no exploration success from continued exploration drilling is experienced–the directors are only focused on funding the company’s ongoing obligations. The conclusion from the analysis is that cash flow from a project may be preferred over selling a project for net present value and then funding the company’s obligations from the proceeds of the sale and declining funds balance. The ultimate lesson for companies is that cash flow, however insignificant, can greatly increase their chances of long-term survival.

Expanded Net Present Value for Various Mining Valuation

2015 ◽  
Vol 21 (4) ◽  
pp. 735-739
Author(s):  
Nandang Sukmana
Keyword(s):  
Net Present Value ◽  
Environmental Issues ◽  
Mine Planning ◽  
Present Value ◽  
Project Valuation ◽  
Quality Costs ◽  
Valuation Process ◽  
Management Flexibility ◽  
High Degree ◽  
Valuation Tools

The purpose of this paper to provide a valuation incorporating management flexibility in an uncertain operating environment for valuing various mining in Indonesia. This research raises the question on what strategies in developing valuations models of various mining and how uncertainty such as prices, grades/quality, costs, schedules, quantities, environmental issues and among others which are not known at the beginning of the project, have contributed to the value resulted. The study is based on an Expanded Net Present Value (eNPV) valuation in which uncertainty and management flexibility are incorporated into the valuation. The focus of the research is on the strategy in determining value using Expanded Net Present Value (eNPV) and on how to mitigate the risks of uncertainties. The paper emphasizes the specific characteristics of the actual mining valuation in Indonesia, generated by conventional NPV method commonly used. This was also confirmed in a study carried out by Graham and Campbell (2002), of 392 completed CFO surveys, 74.9% of respondents always or mostly use the Net Present Value (NPV) method of project valuation. However, conventional valuation tools have penalized projects with a high degree of uncertainty and lead to myopic decisions. The research is correlated to diagnose the flexibility of strategic mine planning and to analyze the process of change within the uncertainties. The study allows emphasis on some characteristics of the mining valuation process developed in Indonesia.

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