Traditional Net Present Value Research Articles

Assessing the Economic Impact of Forest Management in the Brazilian Amazon Through Real Options Analysis

Reduced-impact logging is a key aspect of sustainable forest management in the Brazilian Amazon. Real Options Analysis (ROA) improves the evaluation of certified projects, increases their value, and supports investor confidence. This study evaluates the economic viability of a forest management investment project in certified areas of the Brazilian Amazon, using ROA to incorporate uncertainty and managerial flexibility into the decision-making process. The analysis focused on an Ombrophilous Dense Forest in its first cutting cycle, with 30 species of diameter at breast height ≥ 50 cm and a projected activity period of 30 years. Timber value was modeled using the mean reversion motion, and a binomial decision model was applied, incorporating options such as deferral, abandonment, and interruption. The deferral option should be exercised with a 100% probability, both in the joint calculation scenario and in separate analyses, highlighting the significant value of this managerial flexibility. In addition, when analyzed using ROA, the value of the project increased by 105% (USD 91,784,176) compared to the traditional net present value approach. The forest management investment project in the Brazilian Amazon is economically viable and the application of ROA reveals significant value added, demonstrating the importance of incorporating flexibility into investment decisions.

Investment in CCUS under technical uncertainty considering investor's risk aversion: An exotic compound real-options approach

Carbon capture, utilization, and storage (CCUS) technology is effective and value-adding solution for reducing emissions. However, the development and commercialization of these technologies are challenging due to high investment costs and several uncertainties. This study develops a novel comprehensive real-options-based model to evaluate investment in CCUS projects considering the technical risk and the investor's risk aversion. This study proposed an exotic compound real options model that combines American and barrier options. First, applying the Poison process, the technical risk is explicitly modeled. Secondly, the investor's risk aversion is defined as a barrier level for the barrier option part of the proposed model. Thirdly, the value of the project is evaluated through the exotic compound real option. Finally, we assess the economic viability of the project under multiple scenarios. The results of implementing the model for a real case show that the integrated technical risk assessment and the barrier option appropriately address investors' risk aversion. Furthermore, the comparison indicates that the proposed compound real options model is more effective than the traditional NPV (Net Present Value). Regarding policymaking, the results reveal that setting an appropriate carbon tax that considers the costs of carbon capture would be more beneficial. Further, the model provides investors helpful guidance to make proper investment decisions for CCUS technology projects under uncertainties.

Decision Rules for Corporate Investment

We investigate the decision rules for corporate investment by designing a company value frontier. This company value frontier allows for balancing the financial value and social and environmental impacts. This article develops novel value concepts—ranging from shareholder value to shareholder welfare and integrated value—resulting in varying preferences for social and environmental impacts or values. Next, these preferences are incorporated in investment decision rules. The traditional net present value (NPV) rule optimises only the financial value. We propose a new integrated present value (IPV) decision rule that includes a preference for social and environmental values without neglecting the financial value. By applying the new IPV rule, responsible companies are able to achieve more sustainable outcomes.

Introducing a real option framework for EVA/MVA analysis

The importance of including real option analysis (ROA) in traditional net present value (NPV) analysis has been demonstrated in the literature: ROA values the flexibility to defer, expand, contract, or abandon an investment project, allowing for dynamic decision making. However, methods to apply ROA for firms that utilize economic value added (EVA) and market value added (MVA) for project valuation purposes are not available. This article presents a novel framework that allows for an EVA/MVA analysis to be incorporated into a binomial tree option pricing model. This new EVA/MVA-embedded binomial tree framework not only allows for the consideration of real managerial options within EVA/MVA analysis but also demonstrates its equivalence to the traditional ROA used to adjust NPV. The benefits of this development are that EVA/MVA with an embedded binomial tree is deemed to be an equally valid and robust technique to traditional NPV analysis as opposed to simply being viewed as an alternative or competing measure of project value. This further validates the choice of some firms’ use of EVA/MVA and shows that strategic ROA can be incorporated into corporate decision making.

Accelerating electric vehicle charging investments: A real options approach to policy design

Replacing conventional cars and trucks with battery electric vehicles requires a rapid expansion of fast-charging infrastructure. However, private sector charging infrastructure investments are delayed by unfavorable project economics and uncertainty in future demand. Prior research has addressed the former using standard net present value (NPV) methods, but neglected the latter. To address this gap, this paper introduces a real options model of charging investments, which quantifies the option value of delaying investment under uncertainty. We use this model to assess the implications of optionality in a representative case. Our analysis provides indicative estimates of how investment timing is impacted by alternative policy options: grants, long-term contracts, demand charge re-design, and Zero Emission Vehicle standards. We estimate that if grant subsidies are informed by a traditional NPV analysis, firms would delay investing by more than 5 years. Perhaps surprisingly, even low levels of risk incentivize long delays. We find that policies targeting optionality are substantially more cost-effective than the traditionally used grants. Specifically, we calculate that long-term contracts for differences can trigger immediate investments at a cost 68% lower than grants. A simpler but relatively cost-effective alternative is to introduce a phase-out schedule for grants to discourage investment delays.

Photovoltaic Solar Energy in Forest Nurseries: A Strategic Decision Based on Real Options Analysis

With the growing demand for investment projects in renewable energy, it is essential for the economic feasibility analysis to consider the inherent uncertainties of these projects and enable more accurate investment decisions. In this way, we analyze whether investment projects in photovoltaic panels to produce electrical energy in a forest nursery are economically viable through the analysis of real options. We consider the energy demand of a forest nursery with an initial investment of USD 90,417 in photovoltaic panels. The managerial flexibilities of deferral, expansion of 30.0% of the energy production capacity, and the project’s abandonment were inserted into the binomial model of the decision tree, built in discrete time. The project’s expanded net present value was 79.2% higher than the traditional net present value, capturing the value of flexibilities for managers. The deferral option was the one that most impacted the expanded net present value. Investment projects in photovoltaic panels to produce electricity in a forest nursery are economically viable when analyzed through real options.

Real options analysis applied to investment projects in planted forests of Pinus

Planted forests are long-term projects involving a large monetary contribution, and generally require the incorporation of managerial flexibility. As the traditional methodology for economic evaluation does not allow for the incorporation of these flexibilities, our study aimed to analyze whether investment projects in planted forests of Pinus elliottii Engelm. are economically feasible, by applying a real options analysis. We used empirical data from one hectare of a planted forest of P. elliottii with a 14-year planning horizon. Managerial flexibilities were incorporated in combinations and also separately, as options to defer, expand or abandon the investment project. Through Monte Carlo simulation, the present value of USD 1.016 was conditioned to anticipated return values from the second to the fourteenth year, with a volatility return of 14.5%. With real options analysis, the value of the combined options was USD 29, which, in terms of traditional net present value, showed an expanded net present value of USD 468. The real options analysis thus shows that investment projects in planted forests of P. elliottii are economically feasible. Given that real options analysis is a methodology not widely used in the forestry sector for economic analysis of investment projects, this study can be used to assist forest managers in analysing investment risks and decisions, specifically those related to market fluctuations of planted forests of Pinus spp., assuming that the real options of deferral, expansion and abandonment of an investment project are used.

Risk and Impacts Associated with Marine Carbon Sink Projects: An Example from Guangdong, China

He, Y.; Hu, Y.; Xie, S.; Li, C.; Xu, M., and Chen, X., 2023. Risk and impacts associated with marine carbon sink projects: An example from Guangdong, China. Journal of Coastal Research, 39(2), 246–256. Charlotte (North Carolina), ISSN 0749-0208. This paper aims to measure the risk and impact of the marine carbon sink project in Guangdong, China. This measurement increases the investors' willingness to participate in development and operation of such projects, and promotes the transformation of a low-carbon economy and society. This research employs triangular fuzzy number and Structural Equation Model to develop the risk measurement model of the marine carbon sink project. The net present value and risk equivalent methods measure the impact of risk factors on the project value and investment decision of the representative project in China. The results showed that: (1) there are certain risks in developing marine carbon sequestration projects, including policy, natural, market, and human behavior risks. The comprehensive risk value is 0.444. (2) Among the different types of marine carbon sink risks, the large ones are those caused by storm surges, invasion of alien species, and unknown ownership of marine carbon sink. (3) The risk of marine carbon sequestration reduces the profitability of its projects. (4) Compared with the traditional net present value method, the risk equivalent method is more in line with the development and operation of marine carbon sink projects. Based on this, combined with the risk characteristics and potential factors of marine carbon sequestration projects, and to promote their sustainable development, this paper has the following suggestions: (1) Strengthen policy evaluation and regulation, and formulate policies and measures in line with the development stage of marine carbon sequestration trading. (2) Strengthen the early warning of natural disasters and formulate targeted disaster prevention, mitigation, and relief plans. (3) Strengthen the dynamic supervision of marine carbon sequestration transactions and formulate emergency plans for market transaction risks. (4) Improve public participation and establish a reward and punishment mechanism for human behavior risk prevention and control.

Assessment of investment decisions in bulk shipping through fuzzy real options analysis

The global shipping market has been depressed and turbulent since 2008. Shipping companies have had to be more cautious with their investments, so as to buck the trend and get through this difficult period. Traditional net present value methods cannot help enterprises make effective investment decisions. Therefore, we employ real options theory—including expansion options, contraction options, deferral options, and abandonment options—to simulate various types of operational adjustment strategies used by investors in the process of ship investment and operations. Triangular fuzzy numbers and the generalized autoregressive conditional heteroscedasticity model are also introduced to describe the uncertainty and volatility of the shipping market. Subsequently, a fuzzy real options binomial tree pricing model is developed to assess the project value of ship investments. Based on the calculations and analysis of an actual ship investment case, the fuzzy real options method is shown to be more suitable for ship investment analysis, fitting more closely the actual market and operating situation.

Drop‐in ready jet biofuel from carinata: A real options analysis of processing plant investments

AbstractA promising feedstock for large‐scale production of sustainable jet biofuel is the inedible oilseed Brassica carinata (referred to simply as “carinata”), but transitioning to large‐scale fuel production entails significant economic uncertainty and requires substantial up‐front capital requirements for biorefinery construction. Furthermore, for carinata and other feedstocks attempting to compete within the established fossil jet fuel market, historically volatile aviation fuel prices affect the economic feasibility and return of biorefinery investments. In this study, we assess the impact of jet fuel price volatility on the return on investment in a carinata biorefinery employing a real options analysis (ROA). The key advantage of ROA over traditional net present value (NPV) analysis is that it simultaneously assesses the optimal timing for investments and the impact of jet fuel price dynamics on the likelihood of positive economic returns from investments in processing plants. Given the nonstationary nature of jet fuel prices and the presence of structural breaks, the price series are modeled as a geometric Brownian motion. Taking into account the volatility of jet fuel price, the ROA price threshold for a profitable investment is 45% greater than the NPV threshold. The ROA model identifies the necessary market conditions for a profitable investment and highlights the importance of considering market price dynamics before making substantial capital investments in a carinata biorefinery.

A simulation-based binomial model for building development appraisal

PurposeBuilding developments are often capital intensive, have a long payback period and many associated risks and uncertainties. This makes investments in building projects to be a big challenge. This study aims to develop a computerized simulation-based binomial model (CSBBM) for building investment appraisal with a view to improving the economic sustainability of proposed building projects.Design/methodology/approachMathematical equations and algorithms were developed based on the binomial method (BM) of real options analysis and then implemented on a computer system. A hybrid algorithm that integrates Monte Carlo simulation (MCS) and BM was also developed. A real-life project was used to test the model. Sensitivity analysis was also conducted to explore the influence of input variables on development option value (DOV).FindingsThe test result shows that the model developed provides a better estimate of the value of an investment when compared with traditional net present value technique, which underestimate the value. Moreover, inflation rate (i) and rental value (Ri) are the most sensitive variables for DOV. An increase in i and Ri by just 5% causes a corresponding increase in DOV by 202% and 132%, respectively. While the least sensitive variable is the discount rate (r), as an increase in r by 5% causes a corresponding decrease in DOV by just 9%. The CSBBM is capable of determining the optimal time of development of buildings with an accuracy of 80.77%.Practical implicationsThe hybrid model produces higher DOV than that of only the BM because MCS considers randomness in uncontrollable variables. Thus, building investment decision-makers should always use MCS to complement the BM in an investment analysis.Originality/valueThere is limited evidence on the use of this kind of hybrid model for determining DOV in practice.

Usage of the net present value-at-risk to design ground-coupled heat pump systems under uncertain scenarios

Hybrid ground-coupled heat pump systems can efficiently heat and cool buildings by exchanging heat with geological materials. Their sizing is, however, complex and their financial profitability is hard to establish during the design phase due to uncertainties that taint important design parameters. Historically, impacts of uncertainties are assessed after sizing completion using sensitivity analyses. Unfortunately, these analyses cannot mitigate design risks, should the consequences of uncertainties be significant. Here, we show how the net present value-at-risk, a stochastic financial indicator inspired by a metric used in the financial sector, can weave the impacts of uncertainties throughout the design phase. The net present value-at-risk is compared to the net present value in a case study that considers uncertainty of construction costs, building’s heat load, energy tariffs and ground thermal conductivity. Results show that this financial indicator, although it comes at a higher computational price than traditional net present value indicator, leads to shorter payback periods, greatly reduces the risks of unforeseen financial losses and does not require further sensitivity analysis. By describing uncertain parameters with statistical distributions during sizing, the proposed designs are more conservative, still efficient and financially viable while being shielded from worst case scenarios.

From theoretical real options models to pragmatic decision making: Required steps, opportunities and threats

Port capacity investments are large, irreversible and uncertain projects, involving different decision variables to be optimised. In order to optimise the timing and size of such projects, the literature has indicated that real options (RO) are better suited than the more traditional net present value (NPV) approach. The models are very theoretical and difficult to implement in practice. The objective of this paper is to extend the empirical RO literature in transportation and logistics by bringing continuous-time continuous-state RO models closer to practitioners. This is done by means of developing a blueprint for a practical software application through which port investment managers can easily calculate their optimal decisions. Additionally, the blueprint of this practical implementation allows for a better understanding of the continuous RO logic and way of working. As the discussion of the RO advantages shows, optimising the decision through continuous RO models, rather than applying NPV, can allow ports to realise a much better investment and generate a lot more value from port investment projects. Nevertheless, depending on the specific situation, practitioners might require supplementary assistance of econometricians or consultants to estimate the RO model input parameters. This paper also adds to the literature by quantifying these potential gains and costs.

Human Capital Investment for Adolescents: Barriers and Opportunities

The decision to attend college is a question of human capital investment, yet resources to help practitioners frame human capital investment decisions remain elusive and few include the “gold standard” of finance: net present value (NPV). Can one discuss human capital investment with an average adolescent using a traditional NPV approach? Motivated by this question, we presented 10 barriers to maximizing education–career NPV (e.g., clarity of costs, immature adolescent brains, individual discount rates). We outline an iterative, research-based approach to education–career investment, including framing the conversation, calculating paired NPVs, and structuring the decision. This multistep framework leverages practitioner expertise to help adolescents consider important lifelong financial wellness implications of human capital investment.

Generation of Alternative Battery Allocation Proposals in Distribution Systems by the Optimization of Different Economic Metrics within a Mathematical Model

Battery systems bring technical and economic advantages to electrical distribution systems (EDSs), as they conveniently store the surplus of cheap renewable generation for use at a more convenient time and contribute to peak shaving. Due to the high cost of batteries, technical and economic studies are needed to evaluate their correct allocation within the EDS. To contribute to this analysis, this paper proposes a stochastic mathematical model for the optimal battery allocation (OBA), which can be guided by the optimization of two different economic metrics: net present value (NPV) and internal rate of return (IRR). The effects of the OBA in the EDS are evaluated considering the stochastic variation of photovoltaic generation and load. Tests with the 33-node IEEE test system indicate that OBA results in voltage profile improvement (~1% at peak time), peak reduction (31.17%), increased photovoltaic hosting capacity (18.8%), and cost reduction (3.06%). Furthermore, it was found that the IRR metric leads to a different solution compared to the traditional NPV optimization due to its inherent consideration of the relation between cash flow and investment. Thus, both NPV and IRR-based allocation alternatives can be used by the decision maker to improve economic and technical operation of the EDS.

Human Capital Investment for Adolescents: Barriers and Opportunities

The decision to attend college is a question of human capital investment, yet resources to help practitioners frame human capital investment decisions remain elusive and few include the “gold standard” of finance: Net Present Value (NPV). Can one discuss human capital investment with an average adolescent using a traditional NPV approach? Motivated by this question, we presented 10 barriers to maximizing education-career NPV (e.g., clarity of costs, immature adolescent brains, individual discount rates, etc.). We outline an iterative, research-based approach to education-career investment, including framing the conversation, calculating paired NPVs, and structuring the decision. This multi-step framework leverages practitioner expertise to help adolescents consider important lifelong financial wellness implications of human capital investment.

The Financial Valuation Risk in Pepper Production: The Use of Decoupled Net Present Value

Greenhouse peppers are one of the most important crops globally. However, as in any production activity, especially agricultural, they are subject to important risk factors such as price fluctuations, pests, or the use of bad quality water. This article aims to evaluate the viability of these types of crops by using discounted cash flows. Risk evaluation has been carried out through the analysis of pepper plantations for 2016 and 2017. The traditional application of this tool has significant limitations, such as the discount rate to be used or the estimation of future cash flows. However, by using discount functions that decrease over time in combination with decoupled net present value, these limitations are expected to improve. The use of decoupled net present value has permitted an increase in the accuracy and quantification of risks, isolating the main risks such as price drops (EUR 3720 ha−1 year−1) and structural risks (EUR 1622 € ha−1 year−1). The use of decreasing discount functions has permitted a more realistic investment estimation. Finally, the sensitivity analysis shows that decoupled net present value (DNPV) is little affected by changes in interest rates in contrast to traditional net present value (NPV).

A risk-adjusted decoupled-net-present-value model to determine the optimal concession period of BOT projects

PurposeThe net-present-value (NPV) method is well-known for its drawbacks. To overcome some of these NPV weaknesses this paper aims to provide a methodology to determine an optimal concession period that treats risk and time separately. The purpose of this paper is to apply the notion of risk-adjusted decoupled net present value (risk-adjusted DNPV) to determine a conception period taken into consideration synthetic insurance premiums as compensation for risks.Design/methodology/approachThis paper conducts theoretical and empirical analysis and provides an integrated model for deriving concession periods of any PPP projects. The model is able to capture several contractual issues such risks costing and other contractual scenarios. Methodologically, the paper addressees both the issues of risk-based cost–benefit analysis and cash flow analysis bearing an emphasis of risk-adjusted DNPV to compute an optimum concession period.FindingsThe results show that using DNPV will produce a shorter concession period comparatively to NPV. The consequence of this is that the public sector will gain financially from an earlier transfer of the concession.Research limitations/implicationsThis paper contributes to the PPP literature by combing DNPV and risk to determine the PPP concession period for the mutual benefits both the private and public sectors. The decoupling of risk from traditional NPV computation will allow for risk pricing and tradability through insurance and allocation.Originality/valueThe attempt to decouple time and risk in the computation of NPV is the added value to the body of knowledge.

Evaluating the Investment Projects of Spinal Medical Device Firms Using the Real Option and DANP-mV Based MCDM Methods.

In an era of global aging, spinal and other joint degeneration issues have become a major problem for many elders. Bone-related operations have become the largest percentage of surgeries, accounting for 40% of the top 10 operations in the United States. Further, these spine-related operations are now ranked second among all bone-related operations. Due to this enormous and daily increasing market demand, more and more firms have started to pay closer attention to related medical devices and products. The global venture capitalists (VCs) have also started to follow the mega trend and will continue to invest heavily in this industry. Although most VCs recognize that investing in firms that produce innovative spinal products or devices is a must, very few practical managers or research scholars have defined the appropriate evaluation methods for these firms to use. The traditional net present value (NPV) method, which does not consider operation flexibility and changes in strategy, is far from the reality. The real option method can reveal the vagueness and flexibilities of the values being embedded in the investment projects at spinal medical device firms. However, the real option method is strictly quantitative. Usually, the evaluation aspects contain qualitative factors or local criteria which are hard to quantify in monetary terms. Thus, the adoption of multiple criteria decision making (MCDM) methods that can manipulate both quantitative and qualitative factors will be very helpful in evaluating and selecting investment cases like the spinal medical device firms, where both quantitative and qualitative factors should be considered. An analytical framework that consists of hybrid MCDM methods and the real option method will thus be very useful to evaluate the newly established firms producing spinal medical devices. Therefore, the authors propose a real option valuation as well as the Decision-Making Trial and Evaluation Laboratory (DEMATEL) based analytic network process (DANP) and the modified VIšekriterijumsko KOmpromisno Rangiranje (VIKOR) method (DANP-mV) based MCDM framework for evaluating the investment projects offered by these firms of spinal medical devices. An empirical study based on three newly established spinal medical device companies specializing in vertebral compression fracture (VCF) surgical devices was used to demonstrate the feasibility of the proposed analytical framework. Sensitivity analysis is performed to determine the influence of modeling parameters on ranking results of alternatives. This analytical framework can thus serve as a tool for VCs to use to determine the value of a potential candidate for investment. The proposed method can also serve as an effective and efficient tool for investment projects in other fields.

Carbonvestments: Appraising Investments in a Carbonomics Environment

In 2011, Australia introduced a Carbon Pollution Reduction Scheme (or CPRS) that was a cap-and-trade emissions trading scheme for anthropogenic greenhouse gases. It clearly indicated to companies that polluting the environment with carbon emissions will no longer be free. Companies subject to carbon caps under a carbon trading scheme can either invests in carbon sequestration project and or buy carbon credits to offset their carbon liabilities. While Net Present Value (NPV) has been recorded as the most popular appraisal technique used across the globe for project valuation purposes, finance theorist suggests that using real options (RO) analysis is a more superior techniques to value investment opportunities. Using case study data of an early mover in a CPRS scheme, this paper reveals how RO approach provides more strategic insights than traditional NPV in valuing carbon sequestration investments (termed carbonvestments).