Abstract:
The maritime industry operates in a dynamic global environment subject to a
great number of variables. In this context, the investment challenge facing
shipowners is correctly to value alternate mutually exclusive investment strategies
before proceeding with confidence to commit to a project which will add the
greatest value to the firm. To survive in the competitive market environment
shipping companies must be flexible. Companies that rely solely on traditional
discounted cash flow analysis may be underestimating the true value of their
investment by not valuing any embedded real options specifically. To avoid
misallocation of resources, the true value of these embedded options (strategies)
should be recognised and quantified where possible for inclusion in the capital
budgeting process. Using real options analysis, (ROA), as a development of the
financial pricing advances of the 1970s, flexibility is valued like a financial option
using non-arbitrage and added to the present value of the original strategy to
derive the present value of the flexible strategy. The more uncertainty (risk)
present, the greater will be the value of the real options. Similarly, the larger the
shipowner’s portfolio of options (strategies) from which to choose, the greater
will be the valuation of the project. Real options give the shipowner the flexibility
to exchange one risky income stream associated with one strategy for that of
another. The analysis shows that if managers have the flexibility of more than one
embedded option (in this paper, a European put associated with a replacement
investment and an option on the maximum of two operating strategies, trading or
chartering out) then the project will have greater value than if the there was no
choice or if it was limited to one or the other strategy. Sensitivity analysis extends
the analysis to demonstrate that if the volatilities of the risky income streams are
highly correlated then the additional value of this flexibility will diminish.
