An Assessment of the Option to Reduce the Investment in a Project by the Binomial Pricing Model

Authors

  • Salvador Cruz Rambaud Almería University
  • Ana María Sánchez Pérez Almería University

DOI:

https://doi.org/10.5755/j01.ee.28.5.17636

Keywords:

Real option, option to reduce, binomial pricing model, investment project assessment, financial engineering

Abstract

Real options are a powerful complement to traditional methods of investment project assessment, such as the Net Present Value, when the value of some business strategies has to be included. This paper presents a methodology to calculate the value of the real option to reduce an investment project within one, two, and n periods. It is well known that the option to reduce quantifies the value of the operational flexibility available to protect a business against possible losses generated by the project. Thus, to derive its value, the procedure implemented here consists in obtaining a mathematical expression for each of the aforementioned periods, based on a detailed construction of every possible future scenario and its associated probability by the multiplicative binomial method.

DOI: http://dx.doi.org/10.5755/j01.ee.28.5.17636

Additional Files

Published

2017-12-22

Issue

Section

ECONOMICS OF ENGINEERING DECISIONS