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# "Complex" Real Options - Title Page - MIT

"Complex" Real Options - Title Page - MIT

Probability35%30%25%20%15%10%5%0%\$(2,000) \$(1,500) \$(1,000) \$(500) \$- \$500 \$1,000 \$1,500 \$2,000E(Delta NPV)Figure 5-29 Competitive response with response time of two years.High Efficiency/ High CostPlaneLow Efficiency/ Low CostPlaneOptionAverage: HighEfficiencyPlaneAverage: LowEfficiencyPlaneAverage:OptionComparing the two different response times, the faster response time has the higherE(Delta NPV), with \$570M, compared to \$424M for the four year response. However,the flexibility value for the shorter response time plane is \$430M compared with \$440Mfor the longer response time plane.The shorter response time creates the ability to respond faster to a competitor’s plane,moving forward in time the revenue stream, which increases the net present value due tolowered effects of discount rates. However, the faster response time also forces adecision earlier, when waiting could help resolve additional uncertainty.In this example, there is a trade-off between higher value obtained from moving fasterwith a lower value of flexibility. As the response time moves to zero, the value offlexibility should also decrease toward zero, as less uncertainty is resolved. A responsetime of zero would represent a first-mover, who would have no flexibility to respond to acompetitor and would also likely have an inferior product, given the second-mover coulddesign a slightly superior product, as described above.However, the flexibility of the faster response time should also take into account theability to choose whether the response will occur sooner or later. Taking this intoaccount, the flexibility for the faster response time is the difference in average E(DeltaNPV) between the faster response time flexible value and the slower response timeflexible value, or \$570M - \$424M yielding \$136M that should be added to the total valueof flexibility. This “additional” flexibility creates a total flexibility of \$566M for thefaster response time plane, compared with \$440M for the slower response time plane.The flexibility value to the fast response time plane comes from the ability to exercise theflexibility before or any time up to the same time as the slower response time plane. Ineffect, this is similar to comparing an American option (which can be exercised at anypoint up to a expiration date) and a European option (which can only be exercised on theexpiration date), where American options are always worth at least as much if not more206

than a European option, because of the additional “flexibility” given to the option holderin the actual exercise timing.In this case, it is not clear whether the BWB offers an advantage or not over aconventional plane. This is because a conventional plane could be designed withcommonality that offers this speed to market advantage, as described above with theA350/A350 XWB example to illustrate. Two effects of the commonality are importanthere. The first is the amount of commonality between planes. It is not clear if a BWBtype plane with commonality would have more inter-family commonality than aconventional plane. BWB literature shows about a 39% commonality estimate withanother 33% cousins, which are similar parts but are differentially sized or have minorchanges between planes (Liebeck 2005). Common subsystems in BWB type aircraftinclude common cockpits, common wings and some identical bays. However,conventional aircraft seem to have similar levels of commonality, if optimized acrossmultiple families, like the A330 and A340 families, which share wings, fuselages andcockpits. The level of commonality between planes seems to be similar and is assumedin this model to be similar.The second consideration for commonality though is over the range of families that canshare the commonality. Here it is seems the BWB type aircraft has an advantage, withestimates of commonality across-family sizes at least from 250-450 passengers. This is alarger range of aircraft that has been seen at least to date in conventional aircraft. Ideally,while this commonality may not greatly reduce prices within a family, it extends thenumber of families that could benefit from the reduced commonality.5.3.2.2.2.2 Decision to Enter MarketThe above example assumes that a company can match or exceed the technicalperformance of their competitor’s product. However, the incumbent plane may be tootechnically advanced to match. For example, the original A350 was deemed nottechnically advanced enough by customers to challenge the 787, resulting in pressurefrom customers to come up with a completely new design, with Airbus responding withthe A350 XWB. A BWB type plane as an incumbent could also pose such a challenge,given its greater inherent benefits of fuel-efficiency. Figure 5-30 and Figure 5-31 show ahypothetical match-up between a BWB 250 and BWB 450 and comparably sizedconventional planes.207

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ACKNOWLEDGEMENTSThis dissertation i

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students. I am sure I am missing pe

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6.7 Enterprise and Institutional Ch

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Table 8-8 Summary of existing mode

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Figure 3-17 System management loop

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Figure 5-13 Historical world annual

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Figure 7-19 Decision path for ITS m

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Figure 10-3 Summary of differences

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1. A large commercial aircraft maki

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made to the system are often not on

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From the MIT Engineering Systems Di

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enterprise, the enterprise itself m

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system capable of coping with uncer

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Ch. 2Ch. 3Ch. 4Ch. 7Ch. 5Ch. 8Ch. 6

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applicability of the framework. Fin

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Myers, S. (1977) Determinants of Ca

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FindingsFigure 2-1 Research process

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• Difficult to predict future beh

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As is apparent in the literature, t

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of these. Ideally, either with the

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do not appear to be mutually exclus

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The ability for a system to activel

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price (the option price) for the fl

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and the results can be easier to ex

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For some real options this appears

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there is value to waiting to see wh

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2.5 REAL OPTION PROCESSESExisting p

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option is then evaluated with a “

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• Option to engage in exploration

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elatively straight-forward and are

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OptionComplexityReal option in syst

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2.8 REFERENCESAllen, T. et. al. (20

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Hayes, R. and D. Garvin. (1982) Man

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Ross, A. (2006) Managing Unarticula

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3 LIFE-CYCLE FLEXIBILITY (LCF) FRAM

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3.1 OVERVIEW OF NEED FOR LIFE-CYCLE

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Figure 3-3 Condensed version of the

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level, the appropriate enterprise n

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3.1.2.1 Conceiving an OptionThe abi

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3.1.2.2 Design and Evaluation of Op

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option holder can not exercise the

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system’s underlying structure and

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3.2.2 DECISION TO USE LCF FRAMEWORK

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Figure 3-11 Integration of decision

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ounded rationality is not an issue,

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quantitative analysis chapters, Sec

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meantime, the land now would have d

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3.2.5 DESIGN STRATEGY FOR OPTION EX

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anticipated that external political

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Figure 3-16 illustrates how the str

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3.2.6 MANAGING THE SYSTEMManaging t

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System Management LoopFigure 3-17 S

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System Management LoopSystemImpleme

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Long-term Management Loop ofUnknown

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Long-term Management Loop of Unknow

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Figure 3-23 Condensed LCF Framework

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3.4 REFERENCESAllen, T. et. al. (20

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4 FLEXIBILITY IN BLENDED WING BODY

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4.1.1 THE EARLY YEARSAfter the firs

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Figure 4-2 Sikorsky S-42 Flying Boa

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The 1950’s saw aircraft shift fro

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to the government for doing so, wou

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Figure 4-7 European supersonic civi

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While airlines compete on a variety

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Figure 4-11 Comparison of several l

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Figure 4-12 Foreign and domestic so

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Figure 4-14 Drawings from Leonardo

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shifting their body weight) to the

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Figure 4-19 Semi-monocoque construc

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With a bi-wing (or tri-wing) constr

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Figure 4-24 Loads and lifts generat

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Figure 4-25 747-8, showing both loc

• Page 155 and 156: Additional benefits of the BWB arch
• Page 157 and 158: 4.4.1 BWB OPTION DECISION PATHSFor
• Page 159 and 160: lower costs, higher scales of econo
• Page 161 and 162: Miller, B. (2005) A Generalized Rea
• Page 163 and 164: 5 VALUE OF FLEXIBILITY IN BLENDED W
• Page 165 and 166: This chapter is composed of three m
• Page 167 and 168: this research were deemed necessary
• Page 169 and 170: For clarity of discussion, a high l
• Page 171 and 172: model, a better understanding of co
• Page 173 and 174: An overview of each of these subsys
• Page 175 and 176: important and may make inroads into
• Page 177 and 178: Figure 5-9 Airline finances and pro
• Page 179 and 180: Figure 5-10 Airline profitability,
• Page 181 and 182: Product design is based on a trade-
• Page 183 and 184: The airframe manufacturer productio
• Page 185 and 186: \$70Inflation Adjusted Crude OilPric
• Page 187 and 188: 5.2.5 MODEL VALIDATIONThe system dy
• Page 189 and 190: Forecast data (all planes)Model dat
• Page 191 and 192: 5.3.1 INHERENT BENEFITSBWB technica
• Page 193 and 194: minor differences between aircraft
• Page 195 and 196: The remainder of this section looks
• Page 197 and 198: derivative depends on corporate str
• Page 199 and 200: Table 5-1 Number of derivatives lik
• Page 201 and 202: LowFuelCosts35%30%HighFuelCostsProb
• Page 203 and 204: The results presented can be interp
• Page 205: Compared to the Boeing 787, the dev
• Page 209 and 210: In the opposite case where the BWB
• Page 211 and 212: Because of the consequences of exer
• Page 213 and 214: 35%30%Probability25%20%15%10%5%0%\$-
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• Page 219 and 220: 5.4 REFERENCESAirbus. (2006) Annual
• Page 221 and 222: 6 CHALLENGES OF FLEXIBILITY IN BLEN
• Page 223 and 224: FindingsFigure 6-1 Case study analy
• Page 225 and 226: Figure 6-2 Characteristics of case
• Page 227 and 228: 6.1.3 INTERVIEWEE SELECTIONAs the i
• Page 229 and 230: Table 6-2 ITS case study organizati
• Page 231 and 232: about flexibility, i.e. is it a goo
• Page 233 and 234: 2. If flexibility is used, can you
• Page 235 and 236: case with BCA, which has embraced a
• Page 237 and 238: primarily through military and NASA
• Page 239 and 240: Figure 6-7 Delivery and market fore
• Page 241 and 242: to meet rising demand, the overall
• Page 243 and 244: Another option widespread in the ai
• Page 245 and 246: design, evaluate or manage flexibil
• Page 247 and 248: Interviewee views on flexibility ce
• Page 249 and 250: and evaluations are based around th
• Page 251 and 252: operating and maintenance costs by
• Page 253 and 254: when fuel costs increased substanti
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6.9 REFERENCESAirbus. (2007) Produc

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7 FLEXIBILITY IN HOUSTON GROUNDTRAN

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Figure 7-2 Characteristics of case

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cases can be added to existing or n

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7.2.2 STANDARD ITS TECHNOLOGIES AND

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• increased opportunities for pri

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for Inherently Low Emitting Vehicle

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Marker 2005). This type of cross fu

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Figure 7-4 Plastic pylon separated

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ecause the network of sensors can t

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DSRC based system would require a l

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Houston has already deployed one of

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Figure 7-13 Transit center location

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Figure 7-15 Houston’s managed lan

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as HOT or TOT lanes. This can be es

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HOT / BRTlaneNon-flexibleTOT / BRTl

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or improved safety functions could

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Haning, C. and W. McFarland. (1963)

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8 VALUE OF FLEXIBILITY IN HOUSTON G

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attempt was made to completely repr

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Figure 8-4 Quantitative analysis pr

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8.2.1.1 Travel Demand ModelingThe t

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ange of traffic analysis studies to

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I-10 KatyFreewayI-610(innerloop)Bel

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5 lanesFigure 8-10 Example of satel

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Beltway 8(secondary loop)I-610 (inn

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8.2.2.5 Major Modeling AssumptionsD

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from a public agency that is intere

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funding improvements that would pre

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This is because of the low-cost of

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From the analysis above, with the d

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Figure 8-16 Addition of two general

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capabilities are typically deployab

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Table 8-5 Benefit-Cost Ratios for K

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35%30%25%Probability20%15%10%5%0%\$(

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Figure 8-20 NPV density function, w

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Table 8-6 Summary of flexibility to

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Figure 8-23 Comparison of ITS/delay

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vehicles would continue to gain fre

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Figure 8-24 Value of time savings f

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This illustrates the importance of

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Table 8-10 Summary of ITS case stud

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Similar to the above discussion of

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9 CHALLENGES OF FLEXIBILITY IN HOUS

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new challenges as well as increase

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9.2 QUALITATIVE ANALYSIS PROCESSPre

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The qualitative research methodolog

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to be able to answer the research q

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Table 9-1 Functional activities per

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USDOT, Volpe Center, Officeof Syste

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3. If flexibility is used, can you

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• Increased data sources - The no

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importance that Harris County plays

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Figure 9-7 H-GAC area of responsibi

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Figure 9-9 State level stakeholders

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9.3.2.3 State Legislators and Gover

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The resulting plan forecasted more

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Discussions with interviewees with

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Currently, the cross section of the

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Also of interest is another part of

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y the Southern Pacific Railroad. In

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9.6 PROCESSES FOR IDENTIFYING, DESI

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The federal level interviewee conti

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may not be tied to a physical proje

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During the interview process, sever

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Figure 9-15 Katy Freeway configurat

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Monitor/ManageFigure 9-16 Summary o

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company on a schedule to complete t

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interviewees commented on the ongoi

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facilities has created a lack of wi

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eversible HOV lanes as a safety pre

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the real option and the decision to

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• Mechanism for creating pressure

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9.9.2.2 Uncertainty as a Result of

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option purchase price. This was bec

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9.10 REFERENCESABC7. (2004) Chicago

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Judd, D. and T. Swanstrom. (2004) C

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10 FINDINGS AND CONCLUSIONSChapter

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concerns the use of real options

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Table 10-1 Summary of major researc

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to a system. Rather, these options

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future option exercise can prevent

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Q1-2. The case studies provided a d

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Currently, the Silver Line right-of

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technical system as well as the soc

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In the ITS case study, the transpor

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system that the technical system is

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option exercise unlikely (building

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some future date. This type of wast

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DesignPhaseEvaluationPhaseManagemen

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ITS capabilities used to create the

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technical and social components of

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incorporated directly into the mode

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As defined in Section 2.6, the diff

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In the BWB case study, an enterpris

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For “standard” real options it

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“Standard” real options are des

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From the research it was found that

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d. Evaluating the option with quant

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need for the system is, while simul

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10.7 REFERENCESClemons, E. and B. G

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