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Article
Publication date: 29 July 2014

Jussi Vimpari and Seppo Junnila

The purpose of this study is first to evaluate whether real options analysis (ROA) is suitable for valuing green building certificates, and second to calculate the real

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Abstract

Purpose

The purpose of this study is first to evaluate whether real options analysis (ROA) is suitable for valuing green building certificates, and second to calculate the real option value of a green certificate in a typical office building setting. Green buildings are demonstrated as one of the most profitable climate mitigation actions. However, no consensus exists among industry professionals about how green buildings and specifically green building certificates should be valued.

Design/methodology/approach

The research design of the study involves a theoretical part and an empirical part. In the theoretical part, option characteristics of green building certificates are identified and a contemporary real option valuation method is proposed for application. In the empirical part, the application is demonstrated in an embedded multiple case study design. Two different building cases (with and without green certificate) with eight independent cash flow valuations by eight industry professionals are used as data set for eight valuation case studies and analyses. Additionally, cross-case analysis is executed for strengthening the analysis.

Findings

The paper finds that green certificates have several characteristics similar to real options and supports the idea of using ROA in valuing a green certificate. The paper also explains how option pricing theory and discounted cash flow (DCF) method deal with uncertainty and what shortcomings of DCF could be overcome by ROA. The results show that a mean real option value of 985,000 (or 8.8 per cent premium to the mean property value) was found for a Leadership in Energy and Environmental Design Platinum certificate in the Finnish property market. The main finding of the paper suggests that the contemporary real option valuation methods are appropriate to assess the monetary value and the uncertainty of a green building certificate.

Originality/value

This is the first study to argue that option-pricing theory can be used for valuing green building certificates. The identification of the option characteristics of green building certificates and demonstration of the ROA in an empirical case makes questions whether the current mainstream investment analysis approaches are the most suitable methods for valuing green building certificates.

Details

Journal of European Real Estate Research, vol. 7 no. 2
Type: Research Article
ISSN: 1753-9269

Keywords

Article
Publication date: 1 April 2014

Jussi Vimpari, Juho-Kusti Kajander and Seppo Junnila

The need for flexibility between organisational units is well established in corporate real estate. While the cost of flexibility is rather straightforward to approximate…

Abstract

Purpose

The need for flexibility between organisational units is well established in corporate real estate. While the cost of flexibility is rather straightforward to approximate, measuring economical value of the flexibility is not straightforward. The purpose of this paper is to explore how real options analysis can be used for valuing flexibility in a real retrofit investment case, present a research process for valuing the flexibility in the retrofit investment case, and evaluate the empirical usability of real options valuation results compared with traditional discounted cash flow valuation results.

Design/methodology/approach

The research is conducted as a case study. A newly introduced real options valuation method, the fuzzy pay-off method is used for analysing data from a Finnish office building retrofit investment case. The major difference in the selected method is that it uses fuzzy set theory instead of probabilistic theory, and the main advantage is the practical applicability, i.e. only three scenarios (minimum, best guess, and maximum) are needed for the valuation of flexibility. In the case, the scenarios are determined using a seven-phase research process that incorporates data available (e.g. rental agreements, building information) to a corporate real estate unit. The research process involves defining vacancy scenarios for rental agreements, transforming them into potential income achievable with flexibility, estimating cost of flexibility, comparing the potential income with the costs, and valuing the real options.

Findings

The main finding of this paper is that real options analysis; especially the fuzzy pay-off method can be used for assessing the monetary value of flexibility. The applicability of the fuzzy pay-off method into a practical investment case was found straightforward because assignment of probabilities into different uncertainty scenarios was unnecessary. In the empirical case, it was found that flexibility investments were profitable only when parts of the building instead of the whole building were designed flexible. The present value of the pay-off from flexibility ranged from negative 58/sqm to positive 130/sqm, depending on the tenant.

Originality/value

Real options literature, especially in the real estate and construction sector, has requested for new applications of real options analysis in practical setting. This paper adds to that request with an example of evaluating flexibility in a retrofit investment case. The empirical analysis produced in this paper was perceived valuable by case study investor and can be used as a guidance and motivation for further applications of real options in the industry.

Details

Journal of Corporate Real Estate, vol. 16 no. 1
Type: Research Article
ISSN: 1463-001X

Keywords

Article
Publication date: 8 February 2021

Timothy Oluwafemi Ayodele and Abel Olaleye

This paper aims to investigate the flexible decision pathways adopted by development advisors in the management of uncertainty in property development. Specifically, the…

Abstract

Purpose

This paper aims to investigate the flexible decision pathways adopted by development advisors in the management of uncertainty in property development. Specifically, the study examines the quantitative techniques adopted by development advisors, the level of adoption of real options analysis (ROA) vis-à-vis the level of adoption of heuristics. Finally, the types of options exercised in property development were analysed. This was with a view to providing information that could mitigate the challenges of risk and uncertainty and increasing investment failure associated with property development in Nigeria, an emerging market.

Design/methodology/approach

The study adopted a survey method and was conducted on development advisors in property development companies/estate surveying and valuation firms in Nigeria. A total of 195 development advisors participated in the survey. The respondents were required to rate, on a five-point Likert scale, the level of adoption of the quantitative models, heuristics and the types of flexibility exercised during development. The data were analysed using mean rating, one-sample t-test and analysis of variance.

Findings

The results revealed that there was a preference for the use of traditional techniques, while probabilistic appraisal models and other contemporary methods such as ROA are seldom adopted by development advisors. While there was a significantly high level of adoption of heuristics, the stratified analysis examining the profile of the respondents and the level of adoption of ROA and heuristics suggests that years of experience influenced the level of adoption of both the ROA and heuristics by the development advisors. The analysis of the types of flexibility showed that staging/phasing and changing the initial use/design were the most prevalent flexibility pathways adopted during the development. However, the study found that there was no significant difference concerning the choice of flexibility being adopted by development advisors who used ROA and those who did not.

Practical implications

The study provides an understanding of the decision pathways adopted by development advisors in an emerging market like Nigeria.

Originality/value

The paper contributes to studies on decision-making pathways in the management of uncertainty under dynamic conditions by development advisors in emerging markets.

Details

Journal of Financial Management of Property and Construction , vol. 26 no. 3
Type: Research Article
ISSN: 1366-4387

Keywords

Article
Publication date: 27 September 2021

Mohammad Vahdatmanesh, Afshin Firouzi and James Olabode Bamidele Rotimi

Post-disaster housing reconstruction (PDHR) demands a considerable percentage of global property investment, yet the post-disaster environment presents intricate…

Abstract

Purpose

Post-disaster housing reconstruction (PDHR) demands a considerable percentage of global property investment, yet the post-disaster environment presents intricate challenges to reconstruction financing for governments and at the same time, revenue uncertainty for private investors. The purpose of this study is to develop a methodology for tackling land shortage and the financial challenges of PDHR in the aftermath of a disaster.

Design/methodology/approach

This study developed a methodology based on a combined minimum revenue guarantee and maximum revenue cap model using a well-established real options analysis (ROA) for revenue risk sharing in PDHR projects and land readjustment (LR) for finance. The applicability of the purported model is demonstrated through an illustrative example.

Findings

The results show that flexibility in the options could increase the PDHR contractor’s risk profile by increasing the expected value of the contractor investment and reducing the probability of investment loss. On the other side, a cap on the contractor revenue stream would allow the government to benefit from any excess in revenue and would counterbalance the value of the option.

Practical implications

The framework proposed in this study could serve as a practical risk-revenue sharing in PDHR projects. Governments and policymakers could use the findings to enable the successful delivery of PDHR projects and consequently bring the quality of life of affected people to pre-disaster conditions.

Originality/value

This study can be considered as a first attempt toward the use of the Australian barrier style options structure, and the trinomial lattice valuation model in PDHR projects, which incorporates LR, public-private partnerships, governmental guarantees and PDHR concepts in one ROA-based framework.

Details

Journal of Financial Management of Property and Construction , vol. 27 no. 3
Type: Research Article
ISSN: 1366-4387

Keywords

Article
Publication date: 3 August 2018

Kwabena Mintah, David Higgins and Judith Callanan

Uncertainties in residential property investment performance require that real estate assets are designed in a flexible manner to respond to impacts of market dynamics…

Abstract

Purpose

Uncertainties in residential property investment performance require that real estate assets are designed in a flexible manner to respond to impacts of market dynamics. Though estimating the cost of flexibility is straightforward, assessing the economic value of flexibility is not. The purpose of this study is to explore the potential practical application of real option analysis to determine the economic value of a switching output flexibility embedded in a residential property investment in Australia. The study involves the exploration of an optimal strategy for investment in a residential development through real option analysis and valuation of a mixed use investment.

Design/methodology/approach

The real option valuation model developed by McDonald and Siegel (1986) is adopted for the evaluation because the switching output flexibility is likened to a perpetual American call option with dividend payout.

Findings

Through real option analysis, the economic value of switching output flexibility of the mixed use building was determined to be higher than the initial upfront costs. Moreover, a payoff of about $4million was determined to be the value of the switching output flexibility, therefore justifying upfront investments in flexibility as an uncertainty and risk management tool.

Practical implications

This application is an important demonstration of the practical use of options pricing techniques (real options analysis) and delivers further evidence needed to support the adoption of real option valuation in practice. Flexibility can also enhance risks and uncertainty management in residential property investment better than the adjustment of discount rates.

Originality/value

There is limited evidence on the use of real options techniques for the valuation of switching output flexibility in practice, and this comes as an original application; both the case study and data are all initial applications of switching flexibility in the Australian property market.

Details

Journal of Financial Management of Property and Construction, vol. 23 no. 2
Type: Research Article
ISSN: 1366-4387

Keywords

Article
Publication date: 12 April 2011

Faramak Zandi and Madjid Tavana

The high expenditures in information technology (IT) and the growing usage that penetrates the core of business have resulted in a need to effectively and efficiently…

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Abstract

Purpose

The high expenditures in information technology (IT) and the growing usage that penetrates the core of business have resulted in a need to effectively and efficiently evaluate strategic IT investments in organizations. The purpose of this paper is to propose a novel two‐dimensional approach that determines the deferrable strategy with the most value by maximizing the real option values while minimizing the risks associated with each alternative strategy.

Design/methodology/approach

In the proposed approach, first, the deferrable investment strategies are prioritized according to their values using real option analysis (ROA). Then, the risks associated with each investment strategy are quantified using the group fuzzy analytic hierarchy process. Finally, the values associated with the two dimensions are integrated to determine the deferrable IT investment strategy with the most value using a fuzzy preemptive goal programming model.

Findings

Managers face the difficulty that most IT investment projects are inherently risky, especially in a rapidly changing business environment. The paper proposes a framework that can be used to evaluate IT investments based on the real option concept. This simple, intuitive, generic and comprehensive approach incorporates the linkage among economic value, real option value and IT investments that could lead to a better‐structured decision process.

Originality/value

In contrast to the traditional ROA literature, the approach contributes to the literature by incorporating a risk dimension parameter. The paper emphasizes the importance of categorizing risk management in IT investment projects since some risk cannot be eliminated.

Details

Benchmarking: An International Journal, vol. 18 no. 2
Type: Research Article
ISSN: 1463-5771

Keywords

Article
Publication date: 1 May 2006

Carlos A. Arboleda and Dulcy M. Abraham

The purpose of this paper is to present a methodology to evaluate the capital investments in infrastructure projects managed by private operators considering uncertainties…

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Abstract

Purpose

The purpose of this paper is to present a methodology to evaluate the capital investments in infrastructure projects managed by private operators considering uncertainties in the operation and maintenance of the infrastructure components.

Design/methodology/approach

The methodology described in this paper is based on two major sources of information: deterioration curves of the infrastructure systems obtained from Markov chain models and the value of flexibility obtained from a real options analysis.

Findings

Using this methodology, it is possible to determine whether there is value if project managers adopt flexible strategies in determining capital investments. These strategies refer to the opportunities of postponing, deferring or canceling capital investments required to maintain the operation of the infrastructure systems.

Research limitations/implications

The model utilizes Monte Carlo simulation and real options analysis to overcome the complexities associated with the solution of the differential equations that represent the variability of the main factors in the project cash flow.

Originality/value

The methodology presented in this paper can be used by public officials, private investors, and asset managers to determine the value of flexibility associated with the strategies required to maintain the operation of infrastructure assets.

Details

Engineering, Construction and Architectural Management, vol. 13 no. 3
Type: Research Article
ISSN: 0969-9988

Keywords

Article
Publication date: 22 July 2021

Yarima Sallau Lawal, Aliyu Makarfi Ibrahim, Mu'awiya Abubakar, Ziyadul Hassan Ishaq and Mohammed Mustapha Sa'ad

Building developments are often capital intensive, have a long payback period and many associated risks and uncertainties. This makes investments in building projects to…

Abstract

Purpose

Building developments are often capital intensive, have a long payback period and many associated risks and uncertainties. This makes investments in building projects to be a big challenge. This study aims to develop a computerized simulation-based binomial model (CSBBM) for building investment appraisal with a view to improving the economic sustainability of proposed building projects.

Design/methodology/approach

Mathematical equations and algorithms were developed based on the binomial method (BM) of real options analysis and then implemented on a computer system. A hybrid algorithm that integrates Monte Carlo simulation (MCS) and BM was also developed. A real-life project was used to test the model. Sensitivity analysis was also conducted to explore the influence of input variables on development option value (DOV).

Findings

The test result shows that the model developed provides a better estimate of the value of an investment when compared with traditional net present value technique, which underestimate the value. Moreover, inflation rate (i) and rental value (Ri) are the most sensitive variables for DOV. An increase in i and Ri by just 5% causes a corresponding increase in DOV by 202% and 132%, respectively. While the least sensitive variable is the discount rate (r), as an increase in r by 5% causes a corresponding decrease in DOV by just 9%. The CSBBM is capable of determining the optimal time of development of buildings with an accuracy of 80.77%.

Practical implications

The hybrid model produces higher DOV than that of only the BM because MCS considers randomness in uncontrollable variables. Thus, building investment decision-makers should always use MCS to complement the BM in an investment analysis.

Originality/value

There is limited evidence on the use of this kind of hybrid model for determining DOV in practice.

Details

Journal of Engineering, Design and Technology , vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1726-0531

Keywords

Article
Publication date: 18 October 2011

Alexander Bukhvalov and Barbara Bukhvalova

This paper aims to explain a new idea for the corporate board's main agenda, which should dramatically increase the scale of problems with which the board deals. This

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Abstract

Purpose

This paper aims to explain a new idea for the corporate board's main agenda, which should dramatically increase the scale of problems with which the board deals. This agenda also changes the board's interaction with the management providing a new approach to the agency problem.

Design/methodology/approach

The paper is based on the normative method. The authors rely on cases (only a few are presented here) to illustrate uses of the real option analysis in the approach to the board activities. The paper shows that, on one hand, it is impossible to avoid managerial fraud and misconduct by means of the board's (and authorities’) traditional monitoring, even under the maximum possible toughening of the criminal and civil law, but, on the other hand, it is possible to change the content of the board‐management interaction to prevent fateful events.

Findings

The paper shows how “the duty to say no” approach can prevent corporate failure and, at the same time, facilitate growth and innovation. The underlying basic idea is to use the real options analysis (ROA), which gives an approach to designing strategies under uncertainty. The paper illustrates this technique on different real‐life cases.

Research limitations/implications

The paper's strategic approach does not ignore such traditional issues as remuneration and executives and board turnover. It just shifts the priorities of the board. Obviously, further research is needed to articulate the appropriate approach for various circumstances.

Originality/value

The paper proposes and justifies a dramatic change in the board's duties. It suggests an approach to finding the most important business problems, which require strategic rather than technical decisions; a substitution of the existing “forensic” approach with a “large‐scale” one, turning the board from a policeman into a leader; a change to the style of the board's interaction with the top management of the company.

Details

Corporate Governance: The international journal of business in society, vol. 11 no. 5
Type: Research Article
ISSN: 1472-0701

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Article
Publication date: 18 May 2012

Stephen D. Treanor

The purpose of this paper is to develop a simple model illustrating the benefits of operating a diverse fleet of aircraft.

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Abstract

Purpose

The purpose of this paper is to develop a simple model illustrating the benefits of operating a diverse fleet of aircraft.

Design/methodology/approach

The paper is theoretical. It describes how real options are beneficial to the firm in both capital budgeting and risk management. It illustrates the use of real options in the airline industry, and how real options are used as a risk management tool. Then the model is developed which illustrates how a diverse fleet can provide an airline protection against fuel price risk.

Findings

The results of the model show that a diverse fleet is value enhancing to an airline during periods when fuel prices are high or uncertain. Furthermore, this paper shows that a diverse fleet provides an airline with an operational hedge to jet fuel prices. Though the paper focuses on the airline industry, the results are applicable to those industries vulnerable to volatile input costs, and prohibitive abandonment and re‐entry costs.

Originality/value

The paper uses real option analysis to show the benefits for an airline deriving from operating a diverse fleet of aircraft.

Details

Management Research Review, vol. 35 no. 6
Type: Research Article
ISSN: 2040-8269

Keywords

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