Probabilistic Cash Flow-Based Optimal Investment Timing Using Two-Color Rainbow Options Valuation for Economic Sustainability Appraisement

Yonggu Kim,Eul-Bum Lee,Joseph Ahn,Keeyoung Shin

doi:10.3390/su9101781

Yonggu Kim, Eul-Bum Lee + Show 2 more

Open Access

https://doi.org/10.3390/su9101781

Copy DOI

Abstract

This research determines the optimal investment timing using real options valuation to support decision-making for economic sustainability assessment. This paper illustrates an option pricing model using the Black-Scholes model applied to a case project to understand the model performance. Applicability of the project to the model requires two Monte Carlo simulations to satisfy a Markov process and a Wiener process. The position of project developers is not only the seller of products, but it is also the buyer of raw materials. Real options valuation can be influenced by the volatility of cash outflow, as well as the volatility of cash inflow. This study suggests two-color rainbow options valuation to overcome this issue, which is demonstrated for a steel plant project. The asymmetric results of the case study show that cash outflow (put option) influences the value of the steel plant project more than cash inflow (call option) does of which the discussion of the results is referred to a sensitivity analysis. The real options valuation method proposed in this study contributes to the literature on applying the new model, taking into consideration that investors maximize project profitability for economic sustainable development.

Highlights

Since the U.S was hit by the Global Financial Crisis in 2008, the world economy has declined; a situation that continues to the present time
This study examines a case of cash flow for a steel plant project C (Brazil, 2011), which contains proTfhitiasbsitliutydyimepxaacmt ifnacetsoarscaassseuomfecdasbhasfleodwonfothr eadsatetaelfoprlathnet pprroojjeecctt aCt t(hBartaztiiml,e2.0I1n1t)r,awdihtiiocnhacloDnCtaFins promfiettahboidlist,yaillmpproafcittafbaiclittoyrismapsasuctmfaecdtobr avsaeludesonarethfeixeddataandfoeratchhefapcrtoorjehcatsaotntlhyaotnteimvael.ueI.nHtorawdeivtieorn, al DCifFthmeestehvoadlsu,easllvaprryofidtuaebitloityunimceprtaacitnfeanctvoirovnamluenests,areeacfihxepdroafintadbielaitcyhimfapctaocrt hfaacstoornclaynohnaevveaalue
Equation (2) is used to perform the second Monte Carlo simulation 10,000 times to determine the volatility of the rate of return on the project’s present value (PV) for cash inflow and outflow

Summary

Introduction

Since the U.S was hit by the Global Financial Crisis in 2008, the world economy has declined; a situation that continues to the present time. A real options valuation (ROV), a method to overcome these shortcomings, is suitable for assessing the value of a project because it can estimate the value of business flexibility due to changes in the environment and consider future uncertainties. Project developers are both the sellers of products and the buyers of raw materials. A steel plant project, which is a case study, is a large seller of steel products and a large buyer of iron ores and coal In this case, the cash flow of the project is separated into cash inflow of the sellers and cash outflow of the buyers and applied to the model. A sensitivity analysis is performed to check how differences between the volatilities of cash inflow and cash outflow affect the option value

Literature Review

Background

Findings

Discussion