Real Options Methodology Research Articles

Evaluating responsive gateways amid future uncertainty at the London Bridge station (UK)

The high concentration of people in train stations during rush hour poses a significant risk to passenger comfort and safety. Recent technological advancements in real-time crowd counting and pedestrian microsimulations have made it feasible to create responsive gateways for managing passenger flow to prevent overcrowding situations. This paper proposes a simulation-based cost–benefit analysis, utilising the real options methodology commonly employed to assess flexible infrastructure, to estimate the costs and benefits associated with implementing responsive gateways at the London Bridge station, UK, while considering uncertainties in passenger flow and the interests of various stakeholders. Results from the demonstrative example indicate that responsive gateways offer a better service than static ones mainly due to the expected reduction in the risks related to safety, travel time and comfort, which compensates for a higher cost of installation and maintenance. Further research is envisioned to enhance the modelling of passenger flow uncertainties and expand the objective function to encompass additional externalities. The simulation-based cost–benefit analysis proposed in this paper can be extended to a broader range of intelligent transportation systems, considering uncertainties and their diverse impacts on society. Thus, this paper presents a tool that contributes to a more transparent and objective investment decision making process, particularly concerning the development of smart cities.

Exploring Competence-Based Synergism in Strategic Collaborations: Evidence from the Global Healthcare Industry

One of the most essential issues in business partners’ collaboration is whether the integration of their businesses creates a collaborative synergy and adds market value to merging companies. This paper aims to develop a methodological framework that will be convenient for managerial praxis and helpful for scholars’ research in forecasting explicit synergy and valuing tacit synergy in strategic collaborations. The paper theoretically and empirically contributes twofold to strategic foresight. It employs the ARCTIC framework as an extension of the VRIO model to predict an explicit synergy and real options methodology to measure tacit competence-based synergies in M&A deals. The paper makes several theoretical contributions and managerial implications to corporate finance and strategic management disciplines. Finally, the paper discusses research limitations and future work.

Evaluating the impact of flexible offices in coping with the uncertainty in future demand

The potential growth in working from home poses a large uncertainty in the future demand for office space. Flexible offices can help limit the negative effect of this uncertainty by allowing future changes in use. To ensure that the investment in flexibility is proportioned to the risk that it minimises, the real options methodology is used in this work for modelling the uncertainty in future demand for office space and estimating its effect on stakeholders in the long term. The methodology is tested on an example of a multistorey mixed-tenant office building in Zurich, Switzerland, for which ten designs are proposed and the triggering logic is modelled. The designs have various degrees of flexibility, and the triggering logic mimics the decision criteria of an owner. The results show that under the investigated circumstances, a flexible design with movable walls for enabling periodic conversion of the unrented office space into co-working spaces, and with parcelled technical elements to allow the conversion of long-unrented office space into residential units, is the optimal decision for all involved stakeholders over the building life. The authors draw conclusions about the strengths and limitations of the real options methodology in this context and envision future developments.

Digital Transformation and Real Options: Evaluating the Investment in Cloud ERP

The purpose of this research is to explore and advance the knowledge regarding digital transformation. Toward this end, this paper is focused on the valuation of the assessment methodologies of cloud ERP projects. The investment in digitalization systems entails high levels of uncertainty, which gives these investment projects a high strategic value. The importance of emergent digitalization in ERP systems has made it necessary to use assessment tools that consider strategic information as well as financial information. In this paper, the real options methodology, specifically the option to defer, is proposed to account for the strategic value of investment projects in digitalization. In this sense, an empirical study is conducted by applying the binomial option pricing model to real data on the costs and revenue of investing in cloud ERP to study its viability.

USE OF REAL OPTIONS TO EVALUATE THE PROFITABILITY OF BIOGAS PRODUCTION FROM STILLAGE IN THE TEQUILA INDUSTRY

In Mexico, the tequila industry is the second most important economic activity within the alcoholic beverage industry, after the beer industry. Tequila vinasse is wastewater with a high organic load produced during the distillation of the fermented must of the blue agave (Agave tequilana Weber var. azul), which has a great impact on soils and water bodies in the tequila region. On the other hand, the decrease in fuel reserves causes instability in hydrocarbon prices, which makes it necessary to implement alternative fuel methods such as biogas. In this sense, it has recently been pointed out that the anaerobic digestion process is the most suitable for the treatment of tequila vinasse since it allows the removal of contaminating organic matter, together with the production of biogas that can be used in situ in the tequila industry. In this study, the financial feasibility of the production of biogas for self-consumption from tequila vinasse was calculated with the values achieved from a pilot system composed of a packed bed reactor (PBR) with technological and economic advantages to treat this waste. Profitability was evaluated over a 10-year production horizon (net present value $1 569 001) and was complemented with the Real Options methodology, taking into account price volatility and the option to expand. The results showed that the project is profitable with the 42.85 % biogas production expansion option. It is concluded that biogas production is financially feasible and it is possible to increase the profitability of the system by $6 325 109 if production is expanded.

Managing a High Uncertainty Scenario through a Real Option Assessment: Evidence from a Copper Concentrate Trader

Commodity markets are highly volatile markets where uncertainty management is critical for success. Certain commodities, such as copper concentrates, experience even higher levels of volatility and uncertainty. This is fundamentally due to the absence of a reference market that allows for a transparent price discovery, along with many factors affecting the price and trade of any commodity. Traders also lack the possibility of fully hedging their exposure to copper concentrate prices as there is no derivative market directly available for the commodity. Consequently, this paper analyses the copper concentrate trading business resorting to the Real Options methodology to assess the high volatility and uncertainty which dominates in this area of commodity markets. The results obtained indicate that this method can be applied by copper concentrate traders to separate the price uncertainty from their business operative and financial planning for the future. This provides them with a reliable tool to lower the level of uncertainty affecting their long-term goals, as well as keeping the risk that they are taking under control. It also gives them higher managerial flexibility.

The optimal performance target of valuation adjustment mechanism agreement with real options perspective.

The valuation adjustment mechanism ('VAM') agreement has recently been widely adopted in venture capital investment in emerging markets. The VAM agreement endows venture capital institutions a contractual right to reevaluate invested startup contingent on preset performance targets, which is crucial for the effectiveness of the VAM agreement by deeply affecting the strategy and fate of the startup. Motivated by exploring a rational performance target setting, this paper: 1)Firstly, extracts a general structure of the VAM agreement by cases analysis;2) Secondly, adopts a real options methodology to derive the option value held by venture capital institutions and how the pre-determined performance target affect the payoff of venture capital institutions;3)Thirdly, derives the expected time to achieve the given performance target and the behavior choice of entrepreneurs of startups; 4)Finally, by maximizing the contractual value of venture capital institutions with the participation constraints of the entrepreneur, derives the optimal performance target setting. The result finds that the option value of the VAM agreement is positively related to the performance target. It may partially explain why venture capital institutions tend to dominate overly high targets from a real options perspective. We also confirm the incentive effect of the VAM agreement that entrepreneurs tend to exert their best effort. Furthermore, the derivation of the optimal performance target shows that it is an increased function of the agreement period and a subtractive function of project risk. This paper contributes to the literature on contingent payment mechanisms and provides practical implications for the VAM agreement design.

Real options appraisal for a reactive CSR strategy: the case of Facebook

The present research values reactive corporate social responsibility (CSR) policies using the theory of Real Options (RO). Its main goals are to determine the role of RO methodology as a business risk hedging function on reactive CSR strategies and to analyse whether the application of RO adds value to companies with reactive CSR strategies. The study illustrates Facebook’s reactive CSR policy and also demonstrates that RO can be used serve to hedge market risk (systematic risk), just like their equivalents in the financial markets but also to hedge business risks (non-systematic risk). In addition, it shows that despite the criticism that the use of reactive CSR strategies may arouse, they have a positive impact on the market when used at the right time in companies that do not have a brand positioning closely linked to CSR. Additionally, the article shows that decision-making is a fundamental part of managerial functions and whether the situation is considered as a structured or unstructured problem will determine the action to be taken. In this particular case the reactive CSR strategy relates to waiting as an outcome of a planned choice.

Small companies facing the mobility policy in Spain: Is it profitable to remain in the market?

The parking sector in Spain has experienced a growing trend in recent years. At the same time, the level of market concentration has increased. One of the main reasons behind this phenomenon is due to the mobility policy established both at the national (Spain) and supranational (European Union) levels, which is based on environmental sustainability criteria. Increasingly, the possession of environmental certificates, widespread among large companies but not among small ones, is increasingly decisive to obtain a public parking tender. The objective of this work is to analyze whether small companies, which are a large number in the sector, have possibilities of continuing their activity in the market in the face of an increase in the degree of sustainability in mobility policies. For this purpose, the Real Options methodology will be used, applying an abandonment option for a period of 10 years. The results provide a high NPV value (€598,491.2) and a Real Options value, together with the exit option, of €630,341.9. The exit option contributes a growth of only 5.32% with respect to the NPV. Therefore, the option to stay in the market is an appropriate choice for decision-makers.

POWER GENERATION INVESTMENT TIMING IN A POST COVID-ERA

This paper deals with the optimal timing of power generation investments in the second year of the global COVID-19 pandemic. The research applies the real options methodology during the investment decision-making process and takes, besides a proper uncertainty assessment, the project embedded flexibilities into account. Timing flexibility is discussed thoroughly, and the issue of optimal exercise, the timing of the highest potential value creation is examined through a static and dynamic lens. The authors' initial hypothesis presumed uncertainty as the most influential parameter measured by the project's standard deviation. Timing flexibility, optimal timing is analyzed compared to and concerning this volatility. Static and real options-based dynamic investment timing models are being tested in the power generation industry. Of particular interest of the research is whether results could prove the phenomena of renewable technologies being the safe haven of energy investments after the sector became highly volatile due to the COVID-19 pandemic. Results show that the timing of real options and the value will have a positive relationship. Still, the most exciting finding is that time and timing have a more substantial effect on the created value than uncertainty and further embedded growth potential (more flexibility).Keywords: real options, timing, flexibility, power generation, uncertainty JEL Classifications: G11, C41DOI: https://doi.org/10.32479/ijeep.11815

Real options for a small company in a context of market concentration: A case study of investment in a turbot farming plant in Spain

The Spanish turbot aquaculture sector, the largest in Europe, presents a downward trend in the number of companies that compose it, being especially affected the small companies. The reasons behind this process are mainly due to the incompleteness of its institutional framework. The lack of effective regulation, the insecurity of property rights, the lack of consensus among agents competing for coastal use and the unequal allocation of public resources through subsidies have resulted in a process of concentration that has consolidated the dominance of large companies. As a result of this process, in 2021, the sector is composed of only four companies: two small companies and two large companies. The objective of this article is to provide a valuation framework where the real options methodology is applied to one of the small companies in the market to determine its abandonment possibilities. The results obtained show that the abandon option achieves a significant value, constituting a valid option for decision-makers.

Sustainability in the Aerospace Sector, a Transition to Clean Energy: The E2-EVM Valuation Model

Civil aviation is one of biggest industrial contributors to CO2 emissions worldwide. One of the most urgent problems of this sector is providing new technologies to continue operating in a more sustainable environment through a transition to clean energy. The Earned Value Management (EVM) model, as a traditional project management tool, is continuously being revised with new releases and extensions (e.g., ESM, EDM, QEVM, E-EVM, and ZEVM), but to date none of them has applied an expert judgment criterion to be able to modify and anticipate the final result of the project. In such a way, this paper introduces a novel approach to the topic with the so-called Enhanced and Efficient Earned Value Management (denoted E2-EVM) model by including this new capability through the real options methodology, thus helping to support the sustainability of the aerospace sector. This research focuses on three main goals: the description of recent green initiatives in the aerospace sector by checking its contribution to reaching the well-known Sustainable Development Goals (SDGs), the development of a new version of the EVM model by applying the real options methodology, and, finally, the financial contribution to the aerospace industry by applying these initiatives and methodologies.

Valuing human capital career development: a real options approach

PurposeThere has been a long controversy in the literature on assessing the value of human capital – a long-sought but elusive and challenging task. The ability to quantify flexible human capital (FHC) has been a shortcoming in extant literature. We make a meaningful contribution by showing how real options (RO) methodology can be used to quantify FHC and we provide complementary case study evidence from Fortune 500 “best companies to work for” that the value of employee career development is higher in more volatile sectors in line with real options theory (ROT).Design/methodology/approachThis article provides a prescriptive RO methodology for adopting a more flexible, staged SHRM organizational perspective suitable for uncertain environments, and explores its theoretical and empirical implications through the dual use of RO methodological modelling and multi-case study data involving ten Fortune 500 companies. The case study approach is aimed at creating managerially relevant knowledge. The relevance of our approach to managerial practice is shown through guidelines on how a company like Google might use the RO methodology to estimate the career development option value so as to inform its internal development program for employees to create and capture value.FindingsOur focus is on the staging flexibility in HR as exemplified by the internal career development process. This process can be viewed as a multi-stage (compound) option involving various types of HC uncertainty, HC options, and HR practices. We model staging HR deployment via the option to promote staff employees to middle-level management, itself embedding the option to rise to the top management. To empirically validate our valuation approach, we present case study research that enables quantifying the option value of a career development program and allows assessing how much a mismatch exists in a sample of ten public U.S. companies.Research limitations/implicationsThe overall staging quantification idea is important as it offers guidance as to how to value HR as a sequential investment process under uncertain demand or skill conditions. The analysis is limited to the extent that staged career development might interact with other types of human capital (e.g. switch and learning) options and HR practices (e.g. training). Human resources may also interact with other organizational intangibles, such as brand equity. Our analysis also does not account for psychological considerations from the employees' perspective, such organizational commitment facilitating trust to enable reciprocal commitments, which remains a fruitful subject for future extensions.Practical implicationsROT can provide useful guidance and tools for HR scholars and managers. By keeping tabs on HR-based flexibility value and focusing on the key input variables driving HR flexibility, HR managers can determine the flexibility value unleashed from staging the deployment of HC resources in the face of unanticipated demand and skills shifts.Originality/valueThis is the first paper that attempts to quantify the value of staged career development flexibility using the RO methodology. This article will be cited for its innovativeness in being the first to quantify the value of human capital's contribution to corporate value creation and provide objective evaluation in the context of organizational career-development programs. Besides providing useful insights to scholars, the article also demonstrates how the RO methodology can apply to actual companies and inform managerial practice offering guidelines of relevance to HR practitioners on how to quantify the value of staged HC development in an uncertain environment.

Evaluación financiera con metodología de opciones reales de inversión para producción y venta de café orgánico

En México la cafeticultura es una actividad de gran relevancia debido a la generación de divisas, empleos y a la importancia ecológica del cultivo; sin embargo, debido a la incertidumbre que proporciona el precio, en los últimos 10 años la producción de café cereza decreció a una tasa promedio anual de 6%. Una alternativa para hacer frente a esta crisis es diferenciar el producto y producir café orgánico. La presente investigación se realizó en el 2018 en el municipio de Ixhuatlán, Veracruz. Se calculó la rentabilidad de la producción y venta de café orgánico mediante la evaluación de proyectos de inversión financiera tradicional para los productores y cooperativa (VAN= 1 504 372 y 283 566 respectivamente), se complementó con la metodología de opciones reales; a través, de árboles binomiales, la cual contempla la volatilidad de los precios y el cambio de decisiones que puede tomar el encargado a lo largo del proyecto. El análisis de los resultados mostró que existen mayores beneficios cuando se considera la opción de expansión-abandono a través del cálculo del VAN total de la producción y venta de café orgánico con la metodología de opciones reales (1 959 111 y 411 455, respectivamente).

Dynamic transfer pricing under conditions of uncertainty – the use of real options

PurposeThis paper aims to examine the applicability of real options methodology with respect to developing internal transfer pricing mechanisms. A pervasive theme in existing models is their inability to handle the dynamic and volatile nature of today’s business environment, as well as their lack of objective managerial flexibility. The authors address these and other issues and develop a transfer pricing mechanism based on Black–Scholes and the binomial options pricing methodology, which is better suited in today’s dynamic business environment.Design/methodology/approachThe authors use a conceptual approach in developing theoretical justifications and show, practically, how a transfer price can be developed using two different real options pricing models.FindingsThe authors find that real options transfer price mechanism (real options framework [ROF]) can effectively deal with many of the issues that permeate a modern organization with complex multi-dimensional operations. The authors argue that uncertainty and behavioral issues commonly associated with setting transfer prices are better handled using a transfer pricing mechanism that preserves flexibility at the business unit level, the managerial level and the firm level. The approach allows for different managerial styles in both centralized and decentralized sub-units within the same organization. The authors argue that an open multi-dimensional framework using real options is suitable under conditions of uncertainty and managerial opportunism.Practical implicationsROF-based transfer pricing may be significant in that firms can use it as a tool to manage an organization by setting the prices centrally and at the same time allowing managers to select the transfer price that best suits their specific situation and operating conditions. This may result in a more efficient and more profitable organization.Originality/valueThe contribution of the paper is the melding of the ROF from the finance literature with the accounting problem of setting a transfer price for items lacking a competitive market price. The authors also contribute to existing research by explicitly developing a framework that values managerial flexibility, takes into account uncertainty and considers the behavioral aspects of the transfer pricing process. The authors establish the conditions under which a generic real options model is a feasible alternative in determining a transfer price.

Internet of Things and Their Coming Perspectives: A Real Options Approach

Internet of things is developing at a dizzying rate, and companies are forced to implement it in order to maintain their operational efficiency. The high flexibility inherent to these technologies makes it necessary to apply an appropriate measure, which properly assesses risks and rewards. Real options methodology is available as a tool which fits the conditions, both economic and strategic, under which investment in internet of things technologies is developed. The contribution of this paper is twofold. On the one hand, it offers an adequate tool to assess the strategic value of investment in internet of things technologies. On the other hand, it tries to raise awareness among managers of internet of things technologies because of their potential to contribute to economic and social progress. The results of the research described in this paper highlight the importance of taking action as quickly as possible if companies want to obtain the best possible performance. In order to enhance the understanding of internet of things technologies investment, this paper provides a methodology to assess the implementation of internet of things technologies by using the real options approach; in particular, the option to expand has been proposed for use in the decision-making process.

The unnoticed impact of long-term cost information on wind farms’ economic value in the USA. – A real option analysis

Renewable energies are a natural replacement for conventional or fossil fuel energy generation. One of these sources, wind energy, has exhibited significant cost reductions during the last decades. Even though this historical cost reduction trend is well known in the industry and in the academia, information on this cost trend and volatility has been scarcely incorporated in previous works, thus a natural concern arises when assessing their influence on the economic valuation of wind farms.Moreover, wind projects are modular in size and have a short time-to-market, providing a valuable managerial flexibility to defer investment under non-attractive market conditions, such as high development cost scenarios. Traditional evaluation tools often consider those scenarios, wrongly assuming that wind-developers would move forward with the project under such conditions.Accordingly, this paper analyzes the effect of incorporating both generation cost history and investment flexibility in the valuation of wind farms in the United States using Real Options methodology. Taking two decades of cost data and a reference wind farm, this “uncertainty-flexibility” effect is incorporated and valued, finding that the value of the wind project is 14.2% larger than the one neglecting such effect – where cost stochasticity and managerial flexibility are ignored. Therefore, traditional tools for project valuation, such as discounted cash flow and scenario analysis can no longer solely be used, as they do not properly account for the cost reduction trend, uncertainty, and managerial flexibility that a wind farm could face.

Quantifying barriers to decarbonization of the Russian economy: real options analysis of investment risks in low-carbon technologies

ABSTRACTRussia has significant potential for reducing its carbon emissions. However, investment in new low-carbon technologies has significant risks. Ambiguous energy and climate policy in Russia, along with deterioration of the country's investment climate, create investment barriers that are well described in qualitative terms in the literature. This paper attempts to provide a quantitative analysis of these barriers. For this numerical experiment, we apply the RU-TIMES model. Using a real options methodology, we estimate the risk-adjusted cost of capital in the Russian energy sector (including energy production and consumption technologies represented in the TIMES framework) to be approximately 43% (including a risk-free interest rate) and demonstrate the high risk of investment into energy-efficient and low-carbon technologies. Any future low-carbon emissions pathway depends on the ability of the Russian government to reduce climate and energy policy uncertainties, and to reduce financial risks through improvements of the general investment climate.Key policy insightsThe high cost of capital investment into Russian energy production and consumption may prevent the adoption of new energy-efficient and low-carbon technologies.These investment risks, if not addressed, will delay Russia's low-carbon transition for the coming decades.Adopting a clear and unambiguous long-term climate and energy policy is important to reduce these risks and alleviate some of the barriers to the new technologies.The first step could be ratification of the Paris Agreement and adoption of a long-term emission target for the period up to 2050.

A decision support framework for economic evaluation of flexible strategies in pavement construction projects

ABSTRACTA fuzzy real options methodology is utilised to help highway management organisations select the supreme alternative for project implementation. The uncertainties inherited from input factors, i.e. unit costs of construction work items, unit rates of user costs, annual traffic growth rate and annual discount rate, are addressed through fuzzy set theory, and the managerial flexibilities associated with initial construction, preventive maintenance and rehabilitation are modelled using real options (RO) theory. The framework presented for Pavement Alternative Selection by RO-based Decision Support system (PASRODS) is a software package that has been developed using a Microsoft Excel spreadsheet and Visual Basic for Applications and includes three main components: Database, Model and Reports. PASRODS analyses the project in a year-by-year staged backward dynamic programming solution. Application of PASRODS in a highway project case study in Iran demonstrates that taking the managerial flexibilities into account results in valuing the projects in a more rational and actual manner. On the other hand, considering different attitudes of the decision-maker may lead to changes in alternative ranking and help in selecting supreme one in terms of numerous aspects.

Analysis of tax evasion from the informal market through real options and game theory

In accordance with Article 31, section IV, of the Political Constitution of the United Mexican States, it is established that it is the obligation of Mexicans to contribute to public expenditures, whether of the Federation, of the Federal District or of the State and Municipality in which Reside, in the proportional and equitable manner provided by the laws. It should also be noted that this precept is based on the fact that this obligation considers compliance based on the principles of generality, equity, obligations and transparency in the destination of public spending. However, when citizens perceive that their contributions do not comply with what is established in the regulations in question, there is a so-called tax evasion. Which in accordance with Camargo (2005), that concept is defined as the reduction of an amount of a tax produced within a country by those who are obliged to pay it do not, however, they do obtain benefits through a behaviour fraudulent. Based on this premise, the purpose of this study is to estimate in the best possible way the potential collection that could be obtained by the Federal Government, particularly from the payment of income tax by people who carry out transactions in the informal market, focusing on analysis on the citizens that are dedicated to the sale of merchandise in the markets on wheels, considering simultaneously the benefits that these people would obtain when paying this tribute. For this, 300 surveys were carried out, considering the answers, as well as the application of the Real Options methodology (Trigeorgis et al., 1996) and the Game Theory model (Mas-Colell et al., 1995), the estimation of the collection by expanding the tax base and the benefits in monetary terms at the moment these people enter the formal market.