The Use of Real Options Methodology to Pasturelands Evaluation

K Papanikola,I Mountousi,F Chatzitheo,A Michailidi

doi:10.3844/ajassp.2006.1984.1989

Abstract

This study demonstrates the utility of the real options approach to pasturelands investment analysis. The main objectives are to discuss the real options theory and show how it can be adopted to model uncertainty and managerial flexibility in pasture management (enlargement plan) and investment. Secondly, we show how to calculate the option values of selected options that may be available to managers of pasturelands. The study provides an empirical application, which compares a pasture investment using the static Net Present Value model and real options approach. The results show that according to the Net Present Value criterion, the enlargement plan of the pastureland is economically feasible. However, assuming the presence of uncertainty, application of a real options approach demonstrates that the Net Present Value may lead stakeholders to faulty decisions, as the investment plan is rejected.

Highlights

Traditional stockfarmings of ruminants utilize in a high degree the Greek native grazing lands
A typical investment option is evaluated by applying discounted cash flow (DCF) and a real options approach
While investing in the specific project proved economically feasible according to net present values (NPV) criterion, it is not economically feasible according to a methodology incorporating real options approach

Summary

Introduction

Traditional stockfarmings of ruminants (sheep, goat and cattle) utilize in a high degree the Greek native grazing lands. The classical approach to analyze investment decisions is the use of traditional discounted cash flow (DCF) techniques such as the net present values (NPV), benefit/cost ratio (B/C) and internal rate of return (IRR). The acceptance rule adopts projects where incremental net revenues are greater or equal to incremental investment costs (V ≥ I).

Results

Conclusion