Probabilistic Cash Flow-Based Optimal Investment Timing Using Two-Color Rainbow Options Valuation for Economic Sustainability Appraisement

Abstract

This research determines the optimal investment timing using real options valuation to support decision-making for economic sustainability assessment. This paper illustrates an option pricing model using the Black-Scholes model applied to a case project to understand the model performance. Applicability of the project to the model requires two Monte Carlo simulations to satisfy a Markov process and a Wiener process. The position of project developers is not only the seller of products, but it is also the buyer of raw materials. Real options valuation can be influenced by the volatility of cash outflow, as well as the volatility of cash inflow. This study suggests two-color rainbow options valuation to overcome this issue, which is demonstrated for a steel plant project. The asymmetric results of the case study show that cash outflow (put option) influences the value of the steel plant project more than cash inflow (call option) does of which the discussion of the results is referred to a sensitivity analysis. The real options valuation method proposed in this study contributes to the literature on applying the new model, taking into consideration that investors maximize project profitability for economic sustainable development.

Balancing Project Financing and Mezzanine Project Financing with Option Value to Mitigate Sponsor’s Risks for Overseas Investment Projects

“…Because this study has the same goals, it also uses this methodology. The basic structure is to calculate the option value of the MF based on the volatility of the Project profitability, reflect this in the interest rate, and borrow at this low interest rate [24]. Lee, Cheuk Wing studied the feasibility of applying a hybrid bond, which is a type of MF for Renewable Energy, but analyzed it in terms of only reducing risk, not in deriving the economic value [18].…”

“…Lee, Cheuk Wing studied the feasibility of applying a hybrid bond, which is a type of MF for Renewable Energy, but analyzed it in terms of only reducing risk, not in deriving the economic value [18]. This paper applies the option value to the MF reviewed by Lee, Cheuk Wing [18] based on the volatility of the project profitability used by Kim, Yong-gu [24] and Jung, Young Ki [25] to calculate the interest rate of PF. These results are used to find the optimal ratio of the MF while re-calculating the capital procurement cost and project profitability.…”

A Probabilistic Alternative Approach to Optimal Project Profitability Based on the Value-at-Risk

“…In fact, a Monte Carlo simulation can be easily applied to explain numerous types of practical assumptions regarding the probability distributions of the profitability impact factors of the cash-flow model. The probability distribution for each profitability impact factor of the NPVaR method is determined based on a number of literature researches [15,35,36].…”

“…The DCF method measures the future cash flows of a project from which the gains are converted into the present value (PV) [16]. The DCF method is typically represented by the net present value (NPV) and the internal rate of return (IRR), which are useful in the assessment of a reasonable value in terms of the difference between the present value and the future cash flow value [15]. However, SPPs can be inaccurately assessed when using traditional evaluation methods due to the large size of a project, its long-term operation period, the risk characteristics according to the uncertainty of the contract complexity, varying degrees of management flexibility, and the financial structure [15,[17][18][19].…”

“…A major indicator of project profitability is the results from the DCF method, which is a wellestablished valuation method for steel-plant projects (SPPs), for which cash flows are used [15]. The DCF method measures the future cash flows of a project from which the gains are converted into the present value (PV) [16].…”