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

Yonggu Kim, Keeyoung Shin, Joseph Ahn and Eul-Bum Lee
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Yonggu Kim: Graduate School of Engineering Mastership, Pohang University of Science and Technology, 77, Cheongam-ro, Nam-gu, Pohang-si 37673, Korea
Keeyoung Shin: Technical Research Laboratories, POSCO, 6261, Donghaean-ro, Nam-gu, Pohang-si 37859, Korea
Joseph Ahn: Graduate School of Engineering Mastership, Pohang University of Science and Technology, 77, Cheongam-ro, Nam-gu, Pohang-si 37673, Korea
Eul-Bum Lee: Graduate School of Engineering Mastership, Pohang University of Science and Technology, 77, Cheongam-ro, Nam-gu, Pohang-si 37673, Korea

Sustainability, 2017, vol. 9, issue 10, 1-16

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.

Keywords: economic sustainability appraisement; Monte Carlo simulation; probabilistic cash flow; rainbow real options; optimal investment timing (search for similar items in EconPapers)
JEL-codes: O13 Q Q0 Q2 Q3 Q5 Q56 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:gam:jsusta:v:9:y:2017:i:10:p:1781-:d:113882

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