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A Real Options Approach to Investment Evaluation with a Network Externality

In: The Economics of Online Markets and ICT Networks

Author

Listed:
  • Nadine Bellamy

    (Université d’Evry Val d’Essonne)

  • Jean-Michel Sahut

    (Groupe Sup de Co La Rochelle and Cerege)

Abstract

Conclusion This chapter has developed an analytical framework to understand and quantify the valuation of an investment when network externalities are present. Modeling starts from a probabilistic demand modeling stance and the inclusion of an option to terminate the project. These elements allow the more accurate valuation of the investment. Expected free cash flow values are larger on average than values estimated via the deterministic NPV procedures. However, probabilistic NPV estimates require the calculation of confidence intervals to evaluate project risk. Conversely, the integration of the project termination option (put option) increases the project’s value that is linked to the termination probability and savings from the early abandonment of the project. Finally, while the proposed modeling approach appears more realistic it raises questions as to the best means to obtain values for the termination parameters for effective scenario impleme

Suggested Citation

  • Nadine Bellamy & Jean-Michel Sahut, 2006. "A Real Options Approach to Investment Evaluation with a Network Externality," Contributions to Economics, in: Russel Cooper & Gary Madden & Ashley Lloyd & Michael Schipp (ed.), The Economics of Online Markets and ICT Networks, chapter 11, pages 167-182, Springer.
    • Handle: RePEc:spr:conchp:978-3-7908-1707-2_12
    DOI: 10.1007/3-7908-1707-4_12
    as

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