Simulation methodology for collateralized debt and real options: a new methodology to evaluate the real options of investment using binomial trees and monte carlo simulation

  • Authors:

  • Michele Amico;Zbigniew J. Pasek;Farshid Asl;Giovanni Perrone

  • Affiliations:

  • University of Palermo, Italy;University of Michigan, Ann Arbor, MI;University of Michigan, Ann Arbor, MI;University of Basilicata, Italy

  • Venue:
  • Proceedings of the 35th conference on Winter simulation: driving innovation
  • Year:
  • 2003

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Abstract

This paper deals with a new methodology to evaluate the real operating options embedded in a manufacturing system investment. In a single product framework, the demand is assumed as the main source of uncertainty, therefore as a stochastic variable following a Geometric Brownian Motion (GBM). Then, focusing on the real option to expand the capacity at a certain time in the future, we have developed a new approach for the option payoff, looking forward in the time interval from the expansion date to the end of the planning horizon. The payoff function is the expected Net Present Value (NPV), at the expansion date, of the additional investment to increase the capacity, and it is calculated using Monte Carlo simulation. The option value is computed with a binomial tree algorithm. A numerical example and a sensitivity analysis of the option value as a function of some parameters are finally presented.