Real Options versus Traditional Methods to assess Renewable Energy Projects

Lúcia Santos, Isabel Soares, Carla Mendes and Paula Ferreira

Renewable Energy, 2014, vol. 68, issue C, 588-594

Abstract: Several methods can be employed to evaluate investment in energy production. On one hand, traditional methods (Net Present Value (NPV) or Internal Rate of Return (IRR), for example) ignore certain project characteristics that may influence its evaluation, such as irreversibility, uncertainty and management flexibility. Nevertheless, the Real Option Approach (ROA) has an advantage over the application of traditional methods, since the prior uncertainties are taken into account. Thus, the main objective of this study is to apply ROA to a case-study (mini-hydro plant) through the use of the binomial tree developed by Cox, Ross and Rubinstein in 1979. This study concludes that the value of ROA is higher than the value of NPV because the investor can get better information and uncertainty is reduced when he has the option to defer the investment. In addition to providing a deep analysis on the major gaps in energy investment evaluation, this work contributes to a better understanding of the usefulness of ROA.

Keywords: Energy; Investment analysis; Real options (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (38)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:renene:v:68:y:2014:i:c:p:588-594

DOI: 10.1016/j.renene.2014.01.038

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