Interdependencies between operating options
Name
MIT-EL-88-005WP-19486349.pdf
Size
1.05 MB
Format
Adobe PDF
Checksum (MD5)
1f3340b17a5671456e5030ea4581509e
Author(s)
Kulatilaka, Nalin
Date Issued
1988
Publisher
MIT Energy Lab
Series/Report no.
MIT-EL
88-005WP
Abstract
This paper presents a computationally feasible technique to value
operating flexibilities in making capital budgeting decisions. We investigate
how the value of a project is affected by the simultaneous introduction of
several operating options. Previous studies have focused on operating options
one at a time.
A numerical example demonstrates the options to wait to invest, to
abandon, and to temporarily shut down -- first, one at a time and then more
than one at a time. -- As expected, the project value increases with the
introduction of additional options. Adding new options, however, reduces the
value of the previously available options. We also study the impact of adding
new options on the critical boundaries at which existing options are
exercised. These results help sharpen our intuition about the effects of and
interactions between operating options.
Easiliy implemented on a Personal Computer, the model is sufficiently
general to handle various types of production flexibilities and assumptions
regarding the economic environment. Hence, for the first time, we have
available a quantitative technique that accounts for operating flexibilities
that can be incorporated practically in the capital budgeting process.
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