IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this article or follow this journal

Operational asset replacement strategy: A real options approach

  • Zambujal-Oliveira, João
  • Duque, João

This paper analyses the problem of replacement by investigating the optimal moment of investment replacement in a given tax environment with a given depreciation policy. An operation and maintenance cost minimization model, based on the definition of equivalent annual cost, is applied to a real options paradigm. The developed methodology allows for an innovative evaluation of the flexibility of replacement process analysis. A new two-factor evaluation function is introduced to quantify decisions on asset replacement under a unique cycle environment. This study improves upon previous findings in the literature as it accounts for autonomous salvage value processes. Based on partial differential equations, this model achieves a general analytical solution and particular numerical solution. The results differ significantly from those observed in one-factor models by showing evidence of over-evaluation in optimal levels of replacement, and by confirming suspicions that different types of uncertainties produce non-monotonous effects on the optimal replacement level. The scientific contribution of this study lies in new and stronger approaches to equivalent annual cost literature, supplying an algorithm for operation and maintenance cost minimization that is conditioned by autonomous salvage value. This study also contributes to the real options literature by developing a two-factor model with Brownian processes applied to asset replacement.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.sciencedirect.com/science/article/B6VCT-511K3SY-2/2/f1c8fd60c20cc787a4012b3d4989fa53
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Article provided by Elsevier in its journal European Journal of Operational Research.

Volume (Year): 210 (2011)
Issue (Month): 2 (April)
Pages: 318-325

as
in new window

Handle: RePEc:eee:ejores:v:210:y:2011:i:2:p:318-325
Contact details of provider: Web page: http://www.elsevier.com/locate/eor

References listed on IDEAS
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.:

as in new window
  1. 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.
  2. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-38, June.
  3. Ephraim Clark & Patrick Rousseau, 2002. "Strategic parameters for capital budgeting when abandonment value is stochastic," Applied Financial Economics, Taylor & Francis Journals, vol. 12(2), pages 123-130.
  4. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
  5. Lai, K. K. & Leung, Francis K. N. & Tao, B. & Wang, S. Y., 2000. "Practices of preventive maintenance and replacement for engines: A case study," European Journal of Operational Research, Elsevier, vol. 124(2), pages 294-306, July.
  6. Ian M. Dobbs, 2004. "Replacement Investment: Optimal Economic Life Under Uncertainty," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 31(5-6), pages 729-757.
  7. 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.
  8. Ye, Meng-Hua, 1990. "Optimal replacement policy with stochastic maintenance and operation costs," European Journal of Operational Research, Elsevier, vol. 44(1), pages 84-94, January.
  9. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September.
  10. Rust, John, 1985. "Stationary Equilibrium in a Market for Durable Assets," Econometrica, Econometric Society, vol. 53(4), pages 783-805, July.
  11. Mauer, David C. & Ott, Steven H., 1995. "Investment under Uncertainty: The Case of Replacement Investment Decisions," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(04), pages 581-605, December.
  12. Martzoukos, Spiros H. & Trigeorgis, Lenos, 2002. "Real (investment) options with multiple sources of rare events," European Journal of Operational Research, Elsevier, vol. 136(3), pages 696-706, February.
  13. Yilmaz, Fatih, 2001. "Conditional investment policy under uncertainty and irreversibility," European Journal of Operational Research, Elsevier, vol. 132(3), pages 681-686, August.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:eee:ejores:v:210:y:2011:i:2:p:318-325. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)

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 references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link 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 profile, as there may be some citations waiting for confirmation.

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

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.