Valuation of Interacting Time-to-Build and Growth Real Options in Infrastructure Investments

Olubanjo Michael Adetunji and Akintola Amos Owolabi

International Journal of Economics and Finance, 2016, vol. 8, issue 12, 202-215

Abstract: This paper argues that real options approach presents a better valuation approach for valuing infrastructure investments when compared to traditional discounted cash flow approach. Managerial flexibilities, in various forms of real options, can be incorporated into infrastructure projects to expand the projects¡¯ values. The paper identifies two key types of real options present in infrastructure investments as time-to-build and growth options and extends an earlier developed closed-form option valuation formula to value these options. The paper uses a numerical case of investment in railroad infrastructure project and shows that both types of real options, when embedded in infrastructure projects, add values to the projects. It however shows that the value of growth option is far more than the value of time-to-build option as growth options create opportunities for follow-on investments. It also shows that when the two options are present in an infrastructure investment, the time-to-build real option interacts with the growth option to reduce the latter¡¯s value.

Keywords: capital budgeting; infrastructures; real options; time-to-build option; growth option (search for similar items in EconPapers)
Date: 2016
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