Flexibility and project value: interactions and multiple real options
by Miroslav Culik
International Journal of Operational Research (IJOR), Vol. 11, No. 4, 2011

Abstract: This paper is focused on a project valuation with embedded portfolio of real options including their interactions. Valuation is based on the criterion of net present value (NPV) on the simulation basis. Portfolio includes selected types of European-type real options: option to expand, contract, abandon and temporarily shut down and restart a project. Due to the fact that in reality most of the managerial flexibility takes the form of portfolio of real options, selected types of options are valued not only individually, but also in combination. This paper is structured as follows: firstly, diffusion models for forecasting of output prices and variable costs are derived. Secondly, project value is estimated on the assumption that no real options are present. Finally, project value is calculated with the presence of selected European-type options; these options and their impact on project value are valued first in isolation and consequently in different combinations. Moreover, intrinsic value evolution of given real options with respect to the time of exercising is analysed. In the end, results are presented graphically; selected statistics and risk measures (value at risk, expected shortfall) of the NPV's distributions are calculated and commented.

Online publication date: Sat, 14-Feb-2015

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