Identification and Valuation of Real Options under Risk Preference - Application to Solar PV Leasing in Singapore

Song Shuang

Abstract

Compared to traditional valuation technique such discounted cash flow analysis, which assumes constant cash flows without variability no matter how events unfold, real options approach takes into account of managerial flexibility. This thesis focuses on real options “on” projects, which refer to managerial flexibilities. It discusses the importance of real option thinking and assesses the prospect for solar PV leasing companies in Singapore through the lens of embedded options. The thesis reviews literature on real options and derives an integrated approach to improve the existing valuation methods. A framework used to identify managerial flexibilities is developed and applied to a solar PV leasing case study. A knowledge-based expert system with rules is introduced. Specifically, this research considers the option to expand, if the market condition next year is good. Different approaches of real options valuation including decision analysis and real options analysis are described and results compared. The proposed approach incorporates both utility functions and risk-adjusted discount rate to reflect different types of risks and risk preference. It is demonstrated using the solar PV leasing case study that all three approaches can yield the same valuation under certain conditions. The results of the thesis have several managerial implications. Firstly, it demonstrates that real options have non-negative values through a real-life case study of solar PV leasing. It shows the importance of real option thinking especially when there are uncertainties. Furthermore, the thesis illustrates that decision analysis is a strategic decision-making and valuation approach as it considers more factors. This thesis enables current solar energy planners to consider possible managerial flexibilities under uncertainties such as technological developments. From a real option thinking perspective, it argues that a decision analysis approach could better capture the real options embedded in capital investments than other methods and shows how option thinking can be incorporated in the valuation of solar PV leasing projects. The results showed that with real options, the value of the project can increase significantly compared to the case without real options.