Application of real option analysis for valuing the Japanese construction firms in the international market

Abstract

The Japanese construction firms have been able to keep their sales and shares in the market for many years at the initiative of the government. Recently however, the Japanese economy has been in recession, and public as well as private construction investments have been progressively shrinking according to it. In such a market situation, the Japanese construction firms should improve their productivity or growth rate to manage their firms and keep their assets such as employees. For productivity, firms should make a strong effort to development of human resources, R&D, M&A, and so on. On the other hand, in terms of their growth rate, they should expand their market shares in the Japanese market or enter into a new market including the international market. The research first gives an overview of the current situation of the Japanese construction market and explains the importance of a firm's productivity and growth rate to cope with the shrinking market. Then the research analyzes risks in the international market mainly focusing on volatility of order amounts, currency, interest rates, and political risks. Next, the research examines valuation of a firm using two approaches of Discounted Cash Flow method (or DCF) and Real Option Analysis (or ROA). Basically, DCF can be applied to certainty projects in the Japanese market and ROA can be applied to uncertainty projects in the international market because of a lot of volatilities related to risks in the market. Finally, this research examines strategies for maximizing a firm's value using ROA because ROA help managers understand and quantify a portfolio value of each project.