Investment analysis of deferring a farmer owned ethanol plant: using real options

Ramanathan Shunmugavelu

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: A farmers owned value-added (FOVA) business is often subject to changes in the political situations. So an investment analysis tool that incorporates uncertainty, such as real options is more appropriate. Application of real options is limited in FOVA businesses. In this thesis, the concept of real options is applied under the framework of a farmer owned ethanol plant. The impact of changes in the policy or political situations on ethanol industry is well known. Farmer investors that are currently interested in investing in an ethanol plant should decide whether it is worthwhile to invest now or wait for a year to understand the status of the Renewable Fuels Standard, a major pending policy. In order to make a decision, option values are estimated over a one year period using explicit finite difference method. The findings suggest that the option value is more than the net present value of the ethanol plant. Hence it is worthwhile to wait for one more year.

Date: 2003-01-01
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