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Real Options: Applications in Public Economics

Craig Lawrence and T Mathew

MPRA Paper from University Library of Munich, Germany

Abstract: This paper illustrates the use of real options principles to value prototypical resource and industryinvestment projects. It captures important competitive/strategic dimensions in a step-by-stepanalysis of investment decisions (options) under uncertainty. It compares and contrasts staticdiscounted cash flow analysis (DCF) with real options analysis using three case studies. The initialexample values a resource extraction process using static DCF and then compares the projectvaluation when future information is valued and acted upon. The second example considers a coaldevelopment and uses the binomial valuation approach to capture the option value associated withhaving the right but not the obligation to exit the development. It contrasts this valuation approachagainst static DCF and highlights that future royalty payments could be underestimated if based onthe standard DCF valuation. The third example analyses the impact of providing a subsidy forhybrid vehicle production to accelerate potential uncertain environmental benefits. Lastly, thesuitability of the standard financial and economic evaluation tools used by treasury agencies isconsidered when projects contain real options.

Keywords: financial economics; investment decisions; public economics; externalities; subsidies; project evaluation (search for similar items in EconPapers)
JEL-codes: G10 G11 H10 H23 H43 (search for similar items in EconPapers)
Date: 2008-06-30
New Economics Papers: this item is included in nep-ppm and nep-pub
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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