Flexible Design of Airport System Using Real Options Analysis - MIT

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12/14/2007 1.231 Planning and Design of Airport System Dai Ohama runways’ capacities are related complexly to one another. So, in this project, estimating this capacity is outside of the scope of the goal. I assume that the opposite departure (from north to south) and landing (from south to north) could increase the total capacity of the airport. In other words, PT/W and S/E could increase the capacity. If the demand is more than the capacity, PT/W and S/E should be constructed. If the demand is less than the capacity, it’s not necessary to construct them. Therefore, PT/W and R/E should be constructed when they become necessary. In other words, they don’t have to be constructed until the demand of passengers exceeds the projected capacity. If such flexibility is incorporated into design, managers are able to respond to future risks and uncertainties such as demand of passengers. Therefore, flexible design can minimize the initial investment, reduce risks, respond to uncertainties, and maximize the value of the project. By doing so, this runway extension project would be optimized. 3. Real Options Analysis In order to evaluate those projects, one of the best possible ways is real options analysis, which is an evaluation method for those projects which involve decision opportunities. Real options analysis is the application of financial options theory to the actual projects such as infrastructure developments, real asset investments, research and development, and so on. In these projects, those who make decision generally have options such as the option to defer, the option to defer, and the option to abandon. In this case study, the option to expand should be applied. 3.1 Financial Options Theory Financial options theory is a basis for the real options analysis. In finance, an option contract is an agreement where the owner has the right, but not the obligation, to buy or sell an “underlying asset,” such as a stock, at a pre-determined price on or before the expiration date. [3] There are two types of options in terms of the right. A call option refers to the right to buy a stock at the strike price, the pre-determined price. A put option refers to the right to sell a stock at the strike price. [3] Options are also divided into two categories in terms of Term Project: Flexible Design of Airport System Page 6 of 22
12/14/2007 1.231 Planning and Design of Airport System Dai Ohama expiration date. An American option is exercised when the owners are allowed to exercise them on or before the expiration date. A European option is exercised only on the expiration date. [3] Option is not the obligation but the right to buy or sell the underlying asset. So the owner would exercise the option only when it is favorable to do so. [3] For example, those who hold option would exercise a call option only if the price of the underlying asset (S), is higher than the strike price (K), and would earn a profit of S-K; otherwise, they would buy the asset not from the option, but from the market. A European put option is the right to “sell” the underlying asset at a certain price. So it can be exercised only when the market price of the asset (S) is less than the strike price (K), where those who hold the option can make the profit of K-S. Figure 3-1 shows the general payoff of a European call option and put option. Although American options can be exercised at any time on or before the expiration date, they have the same payoffs as European options. Payoff ($) Underlying Assets S Payoff ($) Underlying Assets S-K K-S Option 0 S=K Asset Price ($) Payoff of European call = Max (S-K, 0) 0 S=K Asset Price ($) Payoff of European put = Max (K-S, 0) Figure 3-1 Payoff Diagram for a European Call Option (Left) and Put Option (Right) Source: R de Neufville Lecture notes of the MIT course of ESD.71 (Fall 2006)[4] 3.1.1 Black-Scholes Option Pricing Model The Black-Scholes option pricing model is the most well-known method. It applies to those European call and put options that do not provide dividends. It can produce the theoretical value of the option by applying five factors such as the price of the underlying asset (S), the strike price (K), the time until expiration (T), the risk-free rate of interest (rf), and the volatility (i.e., standard deviation) of returns on the stock. [3] The following formula shows this model for a European call option. [3] Term Project: Flexible Design of Airport System Page 7 of 22
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Flexible Design of Airport System Using Real Options Analysis - MIT

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