Real Options Analysis as an Economic Evaluation Method for Rainwater Harvesting Systems

Abstract

Rainwater harvesting systems (RWHSs) are increasingly employed to reduce the impact of water scarcity in urban buildings. Implementation depends on their financial feasibility, which is generally assessed using discounted cash flow methods. However, these techniques do not consider uncertainties in demand, rainfall, and water tariffs, which can have considerable effects. This work aims to apply real options analysis (ROA)—which evaluates options by establishing ta value for flexibility—to determine the feasibility of RWHSs. A case study incorporating management flexibility was conducted in three university buildings; it showed that uncertainty can present a strategic opportunity based on the possibility of RWHS expansion. The traditional net present value (NPV) and option value were calculated and compared with the result that ROA increased the NPV by more than five times. Thus, it was confirmed that options pricing increases projects’ values and presents opportunity gains for investments, especially when NPV without flexibility is close to zero. With ROA, systems that do not appear to have economic returns with conventional analysis may become feasible. Therefore, ROA is expected to replace conventional methods in RWHS investment decisions, as it can incorporate uncertainties, making the systems more economically attractive.