Real Options: Applications in Public Economics
AbstractThis paper illustrates the use of real options principles to value prototypical resource and industryinvestment projects. It captures important competitive/strategic dimensions in a step-by-stepanalysis of investment decisions (options) under uncertainty. It compares and contrasts staticdiscounted cash flow analysis (DCF) with real options analysis using three case studies. The initialexample values a resource extraction process using static DCF and then compares the projectvaluation when future information is valued and acted upon. The second example considers a coaldevelopment and uses the binomial valuation approach to capture the option value associated withhaving the right but not the obligation to exit the development. It contrasts this valuation approachagainst static DCF and highlights that future royalty payments could be underestimated if based onthe standard DCF valuation. The third example analyses the impact of providing a subsidy forhybrid vehicle production to accelerate potential uncertain environmental benefits. Lastly, thesuitability of the standard financial and economic evaluation tools used by treasury agencies isconsidered when projects contain real options.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 11915.
Date of creation: 30 Jun 2008
Date of revision:
financial economics; investment decisions; public economics; externalities; subsidies; project evaluation;
Find related papers by JEL classification:
- H10 - Public Economics - - Structure and Scope of Government - - - General
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
- H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-12-07 (All new papers)
- NEP-PPM-2008-12-07 (Project, Program & Portfolio Management)
- NEP-PUB-2008-12-07 (Public Finance)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Krüger, Niclas A. & Svensson, Mikael, 2009. "The impact of real options on willingness to pay for mortality risk reductions," Journal of Health Economics, Elsevier, vol. 28(3), pages 563-569, May.
- Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-57, April.
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