Real options appraisal of forestry investments under information scarcity in biomass markets

Abstract

Technology projects involve the acquisition and development of assets with different natures, such as infrastructure and application software, which might have little value unless other assets are present. Even when the benefits associated with a particular asset can be isolated, they involve a high degree of uncertainty, because their execution is affected by several organizational aspects. The multiple choices necessary for the project development imply different phases and cost schemes, so choosing among these choices has implications for the options available for the project manager once the project has started.Assuming a market environment with scarce information, irreversible investment expenditures, and uncertainty in demand, our paper determines a given implied utilization of the production capacity, that cannot be adjusted later. Facing the indicated environment one major problem arises: defining the optimal implied utilization capable of maximizing the option value of investing. Considering a multi-phase forestry investment project, which comprehends a seed and an expanded investment, complemented with a Kalman filter, our study includes a closed-form solution to estimate the optimal level of implied utilization.This paper provides a structure that estimates the critical values of seed capital forestry investment for technology-based projects, mitigating the risk and scheduling the investment efficiently. It intends to validate a two-phase real options tangible forestry investment model, assuming a seed forestry investment with a reducing effect over the uncertainty management. Thus, by exploring this effect, the model provides the optimal implied utilization and determines the suitable volume of seed capital required to maximize the forestry investment option. It contributes to extending the real options literature by linking forestry investment with implied utilization.