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Valuation of the minimum revenue guarantee and the option to abandon in BOT infrastructure projects

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Author Info
Yu-Lin Huang
Shih-Pei Chou
Abstract

The real option approach is used to value the minimum revenue guarantee (MRG) and the option to abandon in Build-Operate-Transfer infrastructure projects. The option to abandon is formulated under an investment option held by the concessionaire at contract signing and to expire before construction commencement. MRG is formulated as a series of European style put options in a single option pricing model. When combined with the option to abandon in the pre-construction phase, MRG is reconstructed as a series of European style call options to develop a compound option pricing formula. The Taiwan High-Speed Rail Project is chosen as a numerical case to apply the formulas. The results show both MRG and the option to abandon can create values. When MRG and the option to abandon are combined, they will counteract each other and their values will thus be reduced. Increasing the MRG level will decrease the value of the option to abandon, and, at a certain MRG level, the option to abandon will be rendered worthless.

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Publisher Info
Article provided by Taylor and Francis Journals in its journal Construction Management & Economics.

Volume (Year): 24 (2006)
Issue (Month): 4 (April)
Pages: 379-389
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Handle: RePEc:taf:conmgt:v:24:y:2006:i:4:p:379-389

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Related research
Keywords: BOT; infrastructure; real option; option to abandon; minimum revenue guarantee;

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References listed on IDEAS
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  1. S. Ping Ho & Liang Y. Liu, 2002. "An option pricing-based model for evaluating the financial viability of privatized infrastructure projects," Construction Management & Economics, Taylor and Francis Journals, vol. 20(2), pages 143-156, March. [Downloadable!] (restricted)
  2. Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March. [Downloadable!] (restricted)
  3. Trigeorgis, Lenos, 1993. "The Nature of Option Interactions and the Valuation of Investments with Multiple Real Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 28(01), pages 1-20, March. [Downloadable!]
  4. Paddock, James L & Siegel, Daniel R & Smith, James L, 1988. "Option Valuation of Claims on Real Assets: The Case of Offshore Petroleum Leases," The Quarterly Journal of Economics, MIT Press, vol. 103(3), pages 479-508, August. [Downloadable!] (restricted)
  5. Tien Foo Sing, 2002. "Time to build options in construction processes," Construction Management & Economics, Taylor and Francis Journals, vol. 20(2), pages 119-130, March. [Downloadable!] (restricted)
  6. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November. [Downloadable!] (restricted)
  7. Michael J. Garvin & Charles Y. J. Cheah, 2004. "Valuation techniques for infrastructure investment decisions," Construction Management & Economics, Taylor and Francis Journals, vol. 22(4), pages 373-383, May. [Downloadable!] (restricted)
  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 637-54, May-June. [Downloadable!] (restricted)
  9. David N. Ford & Diane M. Lander & John J. Voyer, 2002. "A real options approach to valuing strategic flexibility in uncertain construction projects," Construction Management & Economics, Taylor and Francis Journals, vol. 20(4), pages 343-351, June. [Downloadable!] (restricted)
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