IDEAS home Printed from https://ideas.repec.org/a/gam/jsusta/v9y2017i10p1781-d113882.html
   My bibliography  Save this article

Probabilistic Cash Flow-Based Optimal Investment Timing Using Two-Color Rainbow Options Valuation for Economic Sustainability Appraisement

Author

Listed:
  • Yonggu Kim

    (Graduate School of Engineering Mastership, Pohang University of Science and Technology, 77, Cheongam-ro, Nam-gu, Pohang-si 37673, Korea)

  • Keeyoung Shin

    (Technical Research Laboratories, POSCO, 6261, Donghaean-ro, Nam-gu, Pohang-si 37859, Korea)

  • Joseph Ahn

    (Graduate School of Engineering Mastership, Pohang University of Science and Technology, 77, Cheongam-ro, Nam-gu, Pohang-si 37673, Korea)

  • Eul-Bum Lee

    (Graduate School of Engineering Mastership, Pohang University of Science and Technology, 77, Cheongam-ro, Nam-gu, Pohang-si 37673, Korea)

Abstract

This research determines the optimal investment timing using real options valuation to support decision-making for economic sustainability assessment. This paper illustrates an option pricing model using the Black-Scholes model applied to a case project to understand the model performance. Applicability of the project to the model requires two Monte Carlo simulations to satisfy a Markov process and a Wiener process. The position of project developers is not only the seller of products, but it is also the buyer of raw materials. Real options valuation can be influenced by the volatility of cash outflow, as well as the volatility of cash inflow. This study suggests two-color rainbow options valuation to overcome this issue, which is demonstrated for a steel plant project. The asymmetric results of the case study show that cash outflow (put option) influences the value of the steel plant project more than cash inflow (call option) does of which the discussion of the results is referred to a sensitivity analysis. The real options valuation method proposed in this study contributes to the literature on applying the new model, taking into consideration that investors maximize project profitability for economic sustainable development.

Suggested Citation

  • Yonggu Kim & Keeyoung Shin & Joseph Ahn & Eul-Bum Lee, 2017. "Probabilistic Cash Flow-Based Optimal Investment Timing Using Two-Color Rainbow Options Valuation for Economic Sustainability Appraisement," Sustainability, MDPI, vol. 9(10), pages 1-16, October.
    • Handle: RePEc:gam:jsusta:v:9:y:2017:i:10:p:1781-:d:113882
    as

    Download full text from publisher

    File URL: https://www.mdpi.com/2071-1050/9/10/1781/pdf
    Download Restriction: no
    File URL: https://www.mdpi.com/2071-1050/9/10/1781/
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Cohen, Boyd & Winn, Monika I., 2007. "Market imperfections, opportunity and sustainable entrepreneurship," Journal of Business Venturing, Elsevier, vol. 22(1), pages 29-49, January.
    2. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    3. Michel Benaroch & Robert J. Kauffman, 1999. "A Case for Using Real Options Pricing Analysis to Evaluate Information Technology Project Investments," Information Systems Research, INFORMS, vol. 10(1), pages 70-86, March.
    4. Bøckman, Thor & Fleten, Stein-Erik & Juliussen, Erik & Langhammer, Håvard J. & Revdal, Ingemar, 2008. "Investment timing and optimal capacity choice for small hydropower projects," European Journal of Operational Research, Elsevier, vol. 190(1), pages 255-267, October.
    5. Alexandra Dwyer & George Gardner & Thomas Williams, 2011. "Global Commodity Markets - Price Volatility and Financialisation," RBA Bulletin (Print copy discontinued), Reserve Bank of Australia, pages 49-58, June.
    6. Wilmott,Paul & Howison,Sam & Dewynne,Jeff, 1995. "The Mathematics of Financial Derivatives," Cambridge Books, Cambridge University Press, number 9780521497893.
    7. Rosalinde J.A. Klein Woolthuis, 2010. "Sustainable Entrepreneurship in the Dutch Construction Industry," Sustainability, MDPI, vol. 2(2), pages 1-19, February.
    8. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    9. Chen, Mei-Hsiu, 2010. "Understanding world metals prices--Returns, volatility and diversification," Resources Policy, Elsevier, vol. 35(3), pages 127-140, September.
    10. Zoltan Acs & David Audretsch & Pontus Braunerhjelm & Bo Carlsson, 2012. "Growth and entrepreneurship," Small Business Economics, Springer, vol. 39(2), pages 289-300, September.
    11. Henry A. Odeyinka & John Lowe & Ammar P. Kaka, 2013. "Artificial neural network cost flow risk assessment model," Construction Management and Economics, Taylor & Francis Journals, vol. 31(5), pages 423-439, May.
    12. Trigeorgis, Lenos, 1991. "Anticipated competitive entry and early preemptive investment in deferrable projects," Journal of Economics and Business, Elsevier, vol. 43(2), pages 143-156, May.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Yonggu Kim & Eul-Bum Lee, 2018. "A Probabilistic Alternative Approach to Optimal Project Profitability Based on the Value-at-Risk," Sustainability, MDPI, vol. 10(3), pages 1-24, March.
    2. Min-Sung Kim & Eul-Bum Lee & In-Hye Jung & Douglas Alleman, 2018. "Risk Assessment and Mitigation Model for Overseas Steel-Plant Project Investment with Analytic Hierarchy Process—Fuzzy Inference System," Sustainability, MDPI, vol. 10(12), pages 1-17, December.
    3. Kyeongseok Kim & Ji-Sung Kim, 2018. "Economic Assessment of Flood Control Facilities under Climate Uncertainty: A Case of Nakdong River, South Korea," Sustainability, MDPI, vol. 10(2), pages 1-17, January.
    4. Yijuan Liang & Xiuchuan Xu, 2019. "Variance and Dimension Reduction Monte Carlo Method for Pricing European Multi-Asset Options with Stochastic Volatilities," Sustainability, MDPI, vol. 11(3), pages 1-21, February.
    5. Jae-Il Yoo & Eul-Bum Lee & Jin-Woo Choi, 2018. "Balancing Project Financing and Mezzanine Project Financing with Option Value to Mitigate Sponsor’s Risks for Overseas Investment Projects," Sustainability, MDPI, vol. 10(5), pages 1-21, May.
    6. Dong-Hyun Kim & Eul-Bum Lee & In-Hyeo Jung & Douglas Alleman, 2019. "The Efficacy of the Tolling Model’s Ability to Improve Project Profitability on International Steel Plants," Energies, MDPI, vol. 12(7), pages 1-18, March.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Santos, Lúcia & Soares, Isabel & Mendes, Carla & Ferreira, Paula, 2014. "Real Options versus Traditional Methods to assess Renewable Energy Projects," Renewable Energy, Elsevier, vol. 68(C), pages 588-594.
    2. Kroniger, Daniel & Madlener, Reinhard, 2014. "Hydrogen storage for wind parks: A real options evaluation for an optimal investment in more flexibility," Applied Energy, Elsevier, vol. 136(C), pages 931-946.
    3. Marco Antonio Guimaraes Dias & Jose Paulo Teixeira, 2010. "Continuous-Time Option Games: Review of Models and Extensions," Multinational Finance Journal, Multinational Finance Journal, vol. 14(3-4), pages 219-254, September.
    4. Otto Konstandatos & Timothy J Kyng, 2012. "Real Options Analysis for Commodity Based Mining Enterprises with Compound and Barrier Features," Published Paper Series 2012-3, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    5. Marcel Philipp Müller & Sebastian Stöckl & Steffen Zimmermann & Bernd Heinrich, 2016. "Decision Support for IT Investment Projects," Business & Information Systems Engineering: The International Journal of WIRTSCHAFTSINFORMATIK, Springer;Gesellschaft für Informatik e.V. (GI), vol. 58(6), pages 381-396, December.
    6. Kozlova, Mariia, 2017. "Real option valuation in renewable energy literature: Research focus, trends and design," Renewable and Sustainable Energy Reviews, Elsevier, vol. 80(C), pages 180-196.
    7. Favato, Giampiero & Vecchiato, Riccardo, 2017. "Embedding real options in scenario planning: A new methodological approach," Technological Forecasting and Social Change, Elsevier, vol. 124(C), pages 135-149.
    8. Charalampopoulos, George & Katsianis, Dimitris & Varoutas, Dimitris, 2011. "The option to expand to a next generation access network infrastructure and the role of regulation in a discrete time setting: A real options approach," Telecommunications Policy, Elsevier, vol. 35(9), pages 895-906.
    9. Schachter, J.A. & Mancarella, P., 2016. "A critical review of Real Options thinking for valuing investment flexibility in Smart Grids and low carbon energy systems," Renewable and Sustainable Energy Reviews, Elsevier, vol. 56(C), pages 261-271.
    10. Lin, Boqiang & Wesseh, Presley K., 2013. "Valuing Chinese feed-in tariffs program for solar power generation: A real options analysis," Renewable and Sustainable Energy Reviews, Elsevier, vol. 28(C), pages 474-482.
    11. C. E. Dangerfield & A. E. Whalley & N. Hanley & C. A. Gilligan, 2018. "What a Difference a Stochastic Process Makes: Epidemiological-Based Real Options Models of Optimal Treatment of Disease," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 70(3), pages 691-711, July.
    12. Kitzing, Lena & Juul, Nina & Drud, Michael & Boomsma, Trine Krogh, 2017. "A real options approach to analyse wind energy investments under different support schemes," Applied Energy, Elsevier, vol. 188(C), pages 83-96.
    13. Gordon Briest & Elmar Lukas & Sascha H. Mölls & Timo Willershausen, 2020. "Innovation speed under uncertainty and competition," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 41(8), pages 1517-1527, December.
    14. Alkaraan, Fadi & Northcott, Deryl, 2006. "Strategic capital investment decision-making: A role for emergent analysis tools?," The British Accounting Review, Elsevier, vol. 38(2), pages 149-173.
    15. Fleten, Stein-Erik & Linnerud, Kristin & Molnár, Peter & Tandberg Nygaard, Maria, 2016. "Green electricity investment timing in practice: Real options or net present value?," Energy, Elsevier, vol. 116(P1), pages 498-506.
    16. Sungchul Kim & Ronald Giachetti & Sangsung Park, 2018. "Real Options Analysis for Acquisition of New Technology: A Case Study of Korea K2 Tank’s Powerpack," Sustainability, MDPI, vol. 10(11), pages 1-18, October.
    17. MacDougall, Shelley L., 2015. "The value of delay in tidal energy development," Energy Policy, Elsevier, vol. 87(C), pages 438-446.
    18. Lander, Diane M. & Pinches, George E., 1998. "Challenges to the Practical Implementation of Modeling and Valuing Real Options," The Quarterly Review of Economics and Finance, Elsevier, vol. 38(3, Part 2), pages 537-567.
    19. Jia-Yue Huang & Yun-Fei Cao & Hui-Ling Zhou & Hong Cao & Bao-Jun Tang & Nan Wang, 2018. "Optimal Investment Timing and Scale Choice of Overseas Oil Projects: A Real Option Approach," Energies, MDPI, vol. 11(11), pages 1-22, October.
    20. Carlos Andrés Zapata Quimbayo, 2020. "OPCIONES REALES Una guía teórico-práctica para la valoración de inversiones bajo incertidumbre mediante modelos en tiempo discreto y simulación de Monte Carlo," Books, Universidad Externado de Colombia, Facultad de Finanzas, Gobierno y Relaciones Internacionales, number 138, August.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:gam:jsusta:v:9:y:2017:i:10:p:1781-:d:113882. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: MDPI Indexing Manager (email available below). General contact details of provider: https://www.mdpi.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.