Flexibility In Investment Decisions Research Articles

Valuation of Wind Energy Turbines Using Volatility of Wind and Price

The limitedness of the nonrenewable local energy resources in Israel, even in the background of the later gas fields’ findings, continues to force the state to devote various efforts towards ‘green’ energy development. These efforts include installations, both for the solar and for wind energy, thus improving the diversity of energy sources. While the standard discounted cash flow (DCF) method using the net present value (NPV) criterion is extensively adopted to evaluate investments, the standard DCF method is inappropriate for the rapidly changing investment climate and for the managerial flexibility in investment decisions. In recent years, the real options analysis (ROA) technique has been widely applied in many studies for the valuation of renewable energy investment projects. Taking into account the above background, we apply, in this study, the real options analysis approach for the valuation of wind energy turbines and apply it to the analysis of wind energy economic potential in Israel, which is the context of our work. We hypothesize that due to nature of wind energy production uncertainties, the ROA method is better than the alternative. The novelty of this paper includes the following: real world wind statistics of the Merom Golan site in Israel (velocity 3.73 m/s, with a standard deviation of 2.03 m/s), a realistic power generation estimation (power generation of 1205.84 kW with a standard deviation of about 0.5% in annual value which is worth about 1.3 M$ per annum), and an economic model to evaluate the profitability of such a project. We thus discuss the existing challenges of diversifying renewable energy sources in Israel by adding wind installations. Our motivation is to introduce a method which will allow investors and officials to take into account uncertainties when deciding in investing in such wind installations. The outcomes of the paper, which are obtained using the method of Weibull statistics and the Black–Scholes ROA technique, include the result that market price volatility adds to the uncertainties much more than any wind fluctuations, provided that the analysis is integrated over a long enough time.

A Real Options Approach to Valuate Solar Energy Investment with Public Authority Incentives: The Italian Case

Solar energy investment represents currently a valid reason to support sustainable economic development. In fact, over the last few years, governments have applied different measures to incentivize private consumers and firms to use renewable energies. Photovoltaic (PV) projects are characterized by uncertainty due to meteorological conditions, the unpredictable behavior of government, and managerial flexibility. Since the Net Present Value (NPV) approach is not able to capture these uncertain factors, it was replaced with the Real Options Approach (ROA). The latter method manages to embed flexibility in PV investment using binomial trees. This paper valuates PV investment in all regional areas in Italy using an integrated approach between the discounted cash flows method and real option value, called Expanded Net Present Value (ENPV). We fit the probability of tax benefits into a binomial lattice model after analyzing the geographical position and weather conditions of all regional capitals of Italy. The results show that the cities with high irradiance/temperature have positive NPV and high investment values. On the other hand, while most cities have negative NPV, the inclusion of the flexibility in investment decisions gives additional value to the project, making the ENPV positive and implying an attractive investment opportunity with the possibility of delaying the project. We also propose a sensitivity analysis that shows how the real option value changes when incentive policies of the government become more attractive. This paper contributes to the existing literature in the way of considering financial, meteorological/geographical, and political factors to valuate PV investment.

Organisational change and performance in long-lived small firms: a real options approach

This paper supports two key principles of real options reasoning: (a) the value of waiting and (b) the value of staging. It tests whether real options logic applies to small firms implementing significant changes (e.g. in technology) in a model of small firm performance, estimated on data collected by interviews with entrepreneurs. We found that to achieve a higher value by waiting, a delicate balance of precipitators of change against time until exercise is necessary (e.g. if there were just one or two precipitators, then waiting would certainly raise the value). Similarly, to achieve a higher value by staging, the entrepreneur needs to balance embedding against investment time. Thus, provided that investment time is less than 1¼ years, we found that embedding will raise the value. Overall, this implies that strategic flexibility in investment decisions is necessary for good long-run performance of small firms.

Life cycle oriented evaluation of flexibility in investment decisions for automated assembly systems

Due to fast changing market requirements and short product life cycles, flexibility is one of the crucial characteristics of automated and partly automated assembly systems besides purchasing and operation costs. Since the life cycle of an assembly system is longer than the one of the assembled products, flexibility enables an assembly system to adapt to future product requirements as well as production scenarios. The approach proposed in this paper strives for a systematic and economic measurement of flexibility in investment decisions. It offers methods and key-figures supporting the investment decisions for automated assembly systems. The right levels of flexibility and automation of an assembly system are evaluated by using a set of potential future scenarios of the system's life cycle. Based on two new key-figures called Return on Automation and Return on Flexibility, the approach allows comparing different configurations of an assembly system and therefore supports well-informed investment decisions.

Multi-period transportation network design under demand uncertainty

The ability to make optimal transportation network investments decision is central to the strategic management of transportation systems. The presence of uncertainty in transportation systems presents new challenges in making optimal network investment decisions. In this paper, we develop a multi time period network design problem considering both demand uncertainty and demand elasticity. Such an approach affords the planner the flexibility to delay, change, or even abandon the future network investment. We measure the flexibility of investing over multiple time periods as compared to a single-stage network design decision. Initially, we provide a taxonomy and define many dimensions of transportation network flexibility. This is followed with the development of a flexible network design formulation (FNDP), in which the investment is staged over multiple time periods. The demand is assumed to be separable and the demand elasticity is captured using a negative exponential distribution. We develop the FNDP formulation as bilevel stochastic mathematical programming with complementarity constraints (STOCH-MPEC) in which the bi-level formulation is converted to a single level using non-linear complementarity constraints conditions for user equilibrium (UE) problem. The formulation is implemented on two test networks and the results show the benefits of FNDP over single-stage NDP—measured in terms of increase in present expected system consumer surplus (PESCS)—are in the range of 10–30%. The results clearly demonstrate that under demand uncertainty there are potential benefits of introducing flexibility in investment decisions. Finally, we conduct a sensitivity analysis of FNDP with different budget values and it is observed that certain paradoxical sharp corners are observed at certain budget values.

Are real options more valuable in the presence of agency conflicts?

The theory on real options has extended the traditional net present value rule in order to capture the value of flexibility in investment decisions. Typically, the theory of real options does not take into account agency conflicts (between central and divisional management). In this paper, we investigate the influence of agency conflicts on real options within a LEN-type model. We extend a standard LEN model with investment activities by explicitly considering the possibility to abandon an investment project after all parties involved have received further information about the project’s development. Especially, we analyze how the option’s flexibility value is influenced by the agency conflict. Our analysis shows that the real option alters the trade-off between risk sharing and incentives that underlies the agency conflict. Thereby, situations can occur in which central (and divisional) management evaluates the abandonment option ex ante differently than ex post. Using this framework, we discuss the role of commitment and the advantages of centralization and delegation of the abandonment decision.

Measuring Flexibility in Investment Decisions for Manufacturing Systems

Investment decisions for manufacturing systems are primarily based on three characteristics: cost of purchase and operation, cycle time in connection with maximum capacity and achievable work piece quality. However, such considerations neglect another important criterion: the flexibility that allows a manufacturing system to adapt to future production requirements and structures. The major barrier in integrating flexibility into the decision-making process is the difficulty to measure and compare it due to upcoming production scenarios that are not ultimately definable. Therefore, this paper presents a methodical concept for the evaluation of manufacturing systems using real options in order to incorporate flexibility in the decision-making process.

Managing Operational Flexibility in Investment Decisions: The Case of Intel

Significant attention has been paid to how real options analysis can help in valuing operating flexibility when making major capital investment decisions. But there has been far less study of how to manage such flexibility, particularly in cases where a decision to defer, contract, or expand any one investment program affects a range of other programs, including those outside the firm. Such interrelated investments are increasingly common in a connected economy where products and technologies are designed across firms and industries. 2005 Morgan Stanley.

REAL OPTIONS VOLATILITY ESTIMATION WITH CORRELATED INPUTS

Real Options Analysis (ROA) provides a framework for valuing reactive and proactive managerial flexibility in investment decisions. Estimating the volatility parameter for a real options model is challenging because there are typically no historical returns for the underlying asset and no current market prices. A previously developed method of using simulation to estimate the volatility parameter for a real investment is demonstrated. The effects of serial price correlation and price-demand cross-correlation on volatility parameters developed with this method are explained. Finally, managerial implications of these findings are discussed.

Improving Investment Decision Making by Expanding Key Knowledge with Real Option Tools

Assessment of investment profitability with discounted cash flows has proven insufficient when industry structures change. Managers need an extended flexibility in decision–making that DCF analyzes cannot offer. Real Option valuation as a method for improving flexibility in investment decisions has been widely researched but less used in business. With good support tools it is possible for managers to cross the threshold to Real Option methods and thinking. Real Option spreadsheet tools support both decision–making processes and business learning. They utilize the flexibility that new key knowledge brings to volatile industry situations and lead to better investment decisions.