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Sequential Capital Budgeting as Real Options: The Case of a New DRAM Chipmaker in Taiwan

Author

Listed:
  • Chang-Wen Duan

    (Department of Banking and Finance, Tamkang University, Taiwan, R.O.C.)

  • William T. Lin

    (Department of Finance and Applications, Tamkang University, Taiwan, R.O.C.)

  • Cheng Few Lee

    (Department of Finance and Economics, Rutgers University, U.S.A.)

Abstract

We evaluate the initial public offering price of a new DRAM chipmaker in Taiwan in accordance with the compound real call options model of Lin (2002). The worldwide average sales price is the underlying variable, and the average production cost of the new DRAM foundry is the exercise price. The twin security is defined as a portfolio of DRAM manufacturing firms publicly listed in Taiwan stock markets. We estimate the dividend-like yield with two methods, and find that the yield is negative. The negative dividend-like yield results from the negative correlation between the newly constructed DRAM foundry and its twin security, implying the diversification advantage of a new generation of DRAM foundry with a relative low cost of investment opportunity. We solve the critical value for the multivariate normal integral with the secant method, approximating the integral with the lattice method. It has been found that there is only a 4.6% difference between the market IPO price and the estimated one.

Suggested Citation

  • Chang-Wen Duan & William T. Lin & Cheng Few Lee, 2003. "Sequential Capital Budgeting as Real Options: The Case of a New DRAM Chipmaker in Taiwan," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 6(01), pages 87-112.
    • Handle: RePEc:wsi:rpbfmp:v:06:y:2003:i:01:n:s0219091503000992
    DOI: 10.1142/S0219091503000992
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    References listed on IDEAS

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    1. Andersson, Henrik, 1999. "Capital budgeting in a situation with variable utilisation of capacity - an example from the pulp industry," SSE/EFI Working Paper Series in Business Administration 1999:4, Stockholm School of Economics.
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    Citations

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    Cited by:

    1. Lee, Meng-Yu & Yeh, Fang-Bo & Chen, An-Pin, 2008. "The generalized sequential compound options pricing and sensitivity analysis," Mathematical Social Sciences, Elsevier, vol. 55(1), pages 38-54, January.
    2. Liu, Yu-hong & Jiang, I-Ming & Hsu, Wei-tze, 2018. "Compound option pricing under a double exponential Jump-diffusion model," The North American Journal of Economics and Finance, Elsevier, vol. 43(C), pages 30-53.
    3. Sascha Mölls & Karl-Heinz Schild, 2012. "Decision-making in sequential projects: expected time-to-build and probability of failure," Review of Quantitative Finance and Accounting, Springer, vol. 39(1), pages 1-25, July.
    4. Denise A. Jones, 2018. "Using real options theory to explain patterns in the valuation of research and development expenditures," Review of Quantitative Finance and Accounting, Springer, vol. 51(3), pages 575-593, October.
    5. Chia-Chi Lu & Weifeng Hung & Jyh-Jian Sheu & Pai-Ta Shih, 2011. "Investment with network externality under uncertainty," Review of Quantitative Finance and Accounting, Springer, vol. 36(4), pages 555-564, May.
    6. Ndiaye, A.A. & Armstrong, M., 2013. "Evaluating a small deposit next to an economically viable gold mine in West Africa from the points of view of the mining company, the government and the local community," Resources Policy, Elsevier, vol. 38(2), pages 113-122.

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      More about this item

      Keywords

      Average sales price; CAPM; Compound options; Dividend-like yield; DRAM; Lattice method; Real call options; Secant method; Vector autoregression;
      All these keywords.

      JEL classification:

      • G1 - Financial Economics - - General Financial Markets
      • G2 - Financial Economics - - Financial Institutions and Services
      • G3 - Financial Economics - - Corporate Finance and Governance

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