Analyzing the WiMAX investment costs and NPV distributions for real option valuation

Abstract

Purpose

The purpose of this paper is to analyze the suitability of the real option methods in the valuation of WiMAX networks. Particularly, the shapes of the probability distributions for the investment costs and net present values (NPV) are examined.

Design/methodology/approach

The study analyzes the costs and NPV distributions by simulating an investment project in a rural area. The paper examines the influences of different uncertainty models and the shapes of the resulting investment costs, NPVs, and NPV ratios. The simulated option values are compared to results from different analytical equations.

Findings

The analysis in this study shows that the shape of the uncertainty – or error – in the parameters does not affect the shapes of the investment costs or NPV distribution. Instead, the subject of the uncertainty – i.e. the parameters for which the uncertainty is modeled – matters.

Practical implications

The study shows that the uncertainties and opportunities in network investments may increase the value of the projects dramatically and thus they should be taken into account. The shape of the NPV distribution varies depending on the technology and construction strategy of the network. This makes the real option valuation challenging since the assumptions of the valuation models must be satisfied for reliable results. Analytical option valuation formulas give the same results as simulation, only if the assumptions are sufficiently fulfilled and the parameters properly estimated.

Originality/value

The uncertainty in the service rate growth or population growth parameter influences the resulting distributions. The investment costs are positively skewed and can be approximated by a log‐normal distribution. This makes NPV negatively skewed, which suits badly in the existing analytical option valuation methods assuming log‐normal assets. Also, the NPV ratio is correlated with the investment costs.

Citation

Riihimäki, V. (2009), "Analyzing the WiMAX investment costs and NPV distributions for real option valuation", info, Vol. 11 No. 3, pp. 31-44. https://doi.org/10.1108/14636690910954962