The Project Valuation with Abandonment and Reset Investment Proportion Applying Real Option Method
Affiliation(s)
1 Department of Finance, National Cheng Kung University, Taiwan. 2 Department of Food and Beverage Management, Tatung Institute of Technology, Taiwan.
1 Department of Finance, National Cheng Kung University, Taiwan. 2 Department of Food and Beverage Management, Tatung Institute of Technology, Taiwan.
ABSTRACT
We discuss the valuation of investment project in a firm applying a real option method with abandonment and reset investment proportion. We take the depreciation value of the facilities and the research and development (R & D) fee into consideration. Our contribution is to derive a pricing model of two-stage optimal decisions allowing abandonment and reset investment proposition. Different from the net present value (NPV) or discount cash flow (DCF), the real option method can efficiently catch the uncertainty in the market, and it can help managers to make the optimal policy for the project. We can improve our method for a multi-stage decision model or a continuous decision model in the further researches.
We discuss the valuation of investment project in a firm applying a real option method with abandonment and reset investment proportion. We take the depreciation value of the facilities and the research and development (R & D) fee into consideration. Our contribution is to derive a pricing model of two-stage optimal decisions allowing abandonment and reset investment proposition. Different from the net present value (NPV) or discount cash flow (DCF), the real option method can efficiently catch the uncertainty in the market, and it can help managers to make the optimal policy for the project. We can improve our method for a multi-stage decision model or a continuous decision model in the further researches.
Cite this paper
Hsiao, Y. and Chen, L. (2014) The Project Valuation with Abandonment and Reset Investment Proportion Applying Real Option Method. Journal of Mathematical Finance, 4, 309-317. doi: 10.4236/jmf.2014.45028.
Hsiao, Y. and Chen, L. (2014) The Project Valuation with Abandonment and Reset Investment Proportion Applying Real Option Method. Journal of Mathematical Finance, 4, 309-317. doi: 10.4236/jmf.2014.45028.
References
[1] Robichek, A.A. and Horne, J.C.V. (1967) Abandonment Value and Capital Budgeting. Journal of Finance, 22, 577589. [2] Dyl, E.A. and Long, H.W. (1969) Abandonment Value and Capital Budgeting: Comment. The Journal of Finance, 24, 88-95.
http://dx.doi.org/10.1111/j.1540-6261.1969.tb00345.x [3] Hayes, R. and Garvin, D. (1982) Managing as If Tomorrow Mattered. Harvard Business Review, 60, 71-79. [4] Gray, S. and Whaley, R. (1999) Reset Put Options: Valuation, Risk Characteristics, and an Application. Australian Journal of Management, 24, 1-20.
http://dx.doi.org/10.1177/031289629902400101 [5] Boyle, P.P. and Lau, S.H. (1994) Bumping up against the Barrier with the Binomial Method. Journal of Derivatives, 2, 6-14.
http://dx.doi.org/10.3905/jod.1994.407891 [6] Cheng, W. and Zhang, S. (2000) The Analytics of Reset Options. Journal of Derivatives, 8, 59-71.
http://dx.doi.org/10.3905/jod.2000.319114 [7] Boyle, P.P., Kolkiewicz, A.W. and Tan, K.S. (2001) Valuation of the Reset Options Embedded in Some Equity-Linked Insurance Product. North American Actuarial Journal, 5, 1-18.
http://dx.doi.org/10.1080/10920277.2001.10595994 [8] Kimura, T. and Shinohara, T. (2004) Monte Carlo Analysis of Convertible Bonds with Reset Clauses. European Journal of Operational Research, 168, 301-310.
http://dx.doi.org/10.1016/j.ejor.2004.07.008 [9] Ritchken, P. (1995) On Pricing Barrier Options. Journal of Derivatives, 3, 19-28.
http://dx.doi.org/10.3905/jod.1995.407939 [10] Broadie, M., Glasserman, P. and Kuo, S. (1999) Connecting Discrete and Continuous Path-Dependent Options. Finance and Stochastics, 3, 55-82.
http://dx.doi.org/10.1007/s007800050052 [11] Horfelt, P. (2003) Extension of the Corrected Barrier Approximation by Broadie, Glassman, and Kou. Finance and Stochastics, 7, 231-243.
http://dx.doi.org/10.1007/s007800200077 [12] Ahn, D., Figlewski, S. and Gao, B. (1999) Pricing Discrete Barrier Options with an Adaptive Mesh Model. Journal of Derivatives, 2, 33-44.
http://dx.doi.org/10.3905/jod.1999.319127 [13] Kulatilaka, N. and Perotti, E.C. (1998) Strategic Growth Option. Management Science, 44, 1021-1031.
http://dx.doi.org/10.1287/mnsc.44.8.1021
[1] Robichek, A.A. and Horne, J.C.V. (1967) Abandonment Value and Capital Budgeting. Journal of Finance, 22, 577589. [2] Dyl, E.A. and Long, H.W. (1969) Abandonment Value and Capital Budgeting: Comment. The Journal of Finance, 24, 88-95.
http://dx.doi.org/10.1111/j.1540-6261.1969.tb00345.x [3] Hayes, R. and Garvin, D. (1982) Managing as If Tomorrow Mattered. Harvard Business Review, 60, 71-79. [4] Gray, S. and Whaley, R. (1999) Reset Put Options: Valuation, Risk Characteristics, and an Application. Australian Journal of Management, 24, 1-20.
http://dx.doi.org/10.1177/031289629902400101 [5] Boyle, P.P. and Lau, S.H. (1994) Bumping up against the Barrier with the Binomial Method. Journal of Derivatives, 2, 6-14.
http://dx.doi.org/10.3905/jod.1994.407891 [6] Cheng, W. and Zhang, S. (2000) The Analytics of Reset Options. Journal of Derivatives, 8, 59-71.
http://dx.doi.org/10.3905/jod.2000.319114 [7] Boyle, P.P., Kolkiewicz, A.W. and Tan, K.S. (2001) Valuation of the Reset Options Embedded in Some Equity-Linked Insurance Product. North American Actuarial Journal, 5, 1-18.
http://dx.doi.org/10.1080/10920277.2001.10595994 [8] Kimura, T. and Shinohara, T. (2004) Monte Carlo Analysis of Convertible Bonds with Reset Clauses. European Journal of Operational Research, 168, 301-310.
http://dx.doi.org/10.1016/j.ejor.2004.07.008 [9] Ritchken, P. (1995) On Pricing Barrier Options. Journal of Derivatives, 3, 19-28.
http://dx.doi.org/10.3905/jod.1995.407939 [10] Broadie, M., Glasserman, P. and Kuo, S. (1999) Connecting Discrete and Continuous Path-Dependent Options. Finance and Stochastics, 3, 55-82.
http://dx.doi.org/10.1007/s007800050052 [11] Horfelt, P. (2003) Extension of the Corrected Barrier Approximation by Broadie, Glassman, and Kou. Finance and Stochastics, 7, 231-243.
http://dx.doi.org/10.1007/s007800200077 [12] Ahn, D., Figlewski, S. and Gao, B. (1999) Pricing Discrete Barrier Options with an Adaptive Mesh Model. Journal of Derivatives, 2, 33-44.
http://dx.doi.org/10.3905/jod.1999.319127 [13] Kulatilaka, N. and Perotti, E.C. (1998) Strategic Growth Option. Management Science, 44, 1021-1031.
http://dx.doi.org/10.1287/mnsc.44.8.1021