A real options framework to evaluate investments in toll road projects delivered under the two‐phase development strategy

A real options framework to evaluate investments in toll road projects delivered under the... Purpose – This paper aims to present a financial valuation framework based on the real options theory to evaluate investments in toll road projects delivered under the two‐phase development plan. Design/methodology/approach – The approach is based on applying the real options theory to evaluate investments in toll road projects. In particular, the risk‐neutral valuation method is used for pricing flexibility embedded in the two‐phase development plan. Risk‐neutral binomial lattice is used to model traffic uncertainty and to find the optimal time for the toll road expansion. Probabilistic life cycle cost and revenue analysis is conducted to characterize the investor's financial risk profile and determine the flexibility value of the expansion option. Findings – The flexible, two‐phase development plan can improve the investor's financial risk profile in the toll road project through limiting the downside risk of overinvestment (i.e. decreasing the probability of investment loss) and increasing the expected investment value in a highway project. Social implications – Private and public sectors can benefit from this valuation framework and use tax dollars and users' fees effectively through avoiding overinvestment in toll road projects. Originality/value – The framework consists of several integrated features, which distinguish it from existing investment valuation models. The risk‐neutral valuation method for pricing flexibility embedded in the two‐phase development plan is applied. This real options framework is capable of characterizing traffic boundary, at which it is optimal for the investor to expand the toll road. Further, this framework provides the likelihood distribution of when the investor may expand the toll road. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Built Environment Project and Asset Management Emerald Publishing

A real options framework to evaluate investments in toll road projects delivered under the two‐phase development strategy

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Publisher
Emerald Publishing
Copyright
Copyright © 2011 Emerald Group Publishing Limited. All rights reserved.
ISSN
2044-124X
DOI
10.1108/20441241111143759
Publisher site
See Article on Publisher Site

Abstract

Purpose – This paper aims to present a financial valuation framework based on the real options theory to evaluate investments in toll road projects delivered under the two‐phase development plan. Design/methodology/approach – The approach is based on applying the real options theory to evaluate investments in toll road projects. In particular, the risk‐neutral valuation method is used for pricing flexibility embedded in the two‐phase development plan. Risk‐neutral binomial lattice is used to model traffic uncertainty and to find the optimal time for the toll road expansion. Probabilistic life cycle cost and revenue analysis is conducted to characterize the investor's financial risk profile and determine the flexibility value of the expansion option. Findings – The flexible, two‐phase development plan can improve the investor's financial risk profile in the toll road project through limiting the downside risk of overinvestment (i.e. decreasing the probability of investment loss) and increasing the expected investment value in a highway project. Social implications – Private and public sectors can benefit from this valuation framework and use tax dollars and users' fees effectively through avoiding overinvestment in toll road projects. Originality/value – The framework consists of several integrated features, which distinguish it from existing investment valuation models. The risk‐neutral valuation method for pricing flexibility embedded in the two‐phase development plan is applied. This real options framework is capable of characterizing traffic boundary, at which it is optimal for the investor to expand the toll road. Further, this framework provides the likelihood distribution of when the investor may expand the toll road.

Journal

Built Environment Project and Asset ManagementEmerald Publishing

Published: Jul 8, 2011

Keywords: Toll road; Two‐phase development plan; Real options analysis; Risk‐neutral valuation method; Binomial lattice; Optimal expansion time; Flexibility; Expansion option; Road transport; Financial risk

References

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