A Real Options Model to Evaluate Investments in Photovoltaic (PV) Systems

Abstract

Transformative technologies such as Photovoltaic (PV) system have promising features for substantial reductions in carbon emissions and environmental footprints of the building sector. Nevertheless, investment in PV systems requires substantial implementation costs followed by a long period of recovering the invested capital through savings in electricity bills. An appropriate investment valuation method is needed to conduct tradeoff analysis between electricity saving benefits and implementation costs, and find the proper investment values of PV systems. Currently, the valuation of investments in PV systems are made based on the conventional methods, such as payback period, return on investment (ROI) and net present value (NPV) (Muldavin 2010; Prindle and de Fontaine 2009). However, these methods have considerable limitations for the proper valuation of the investments in PV systems for buildings. The existing methods do not address two major issues that impact the value of such investments: uncertainty and timing. We present new approach towards the valuation of investments in PV system for buildings that challenges the theoretical foundation of current investment valuation methods. We utilize the Real Options Theory to overcome the limitations of existing investment valuation methods. We propose a novel investment valuation model that accounts for changes in the implementation costs of PV systems as well as uncertainty about their respective electricity saving benefits. This investment valuation model can be used to find the optimal time for implementing PV systems for buildings, as well as the financial value of properly-timed investments in PV systems.