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"Complex" Real Options - Title Page - MIT

"Complex" Real Options - Title Page - MIT

made to the system are

made to the system are often not only directed at current issues but also anticipated ordesired future issues; this is inherently difficult due to uncertainty, where uncertainty canreside in the system itself and in the surrounding environment. Fourth, due to evaluativecomplexity, agreement between different stakeholders on the value of coping withdisruptions is difficult to achieve (Sussman 2002).Dealing with uncertainty when designing, implementing and sustaining solutions toproblems in complex systems is the major focus of this research.For this research, a Life-Cycle Flexibility (LCF) Framework is developed and is thenapplied to two complex system case studies. The case studies were chosen to act as a testbed to exercise the LCF Framework and DVD concept and to better understand flexibilityin these respective case study domains. A brief description of the case studies follows.1.1.1 AIRCRAFT ENTERPRISESLarge aircraft comprised of 100+ seats and comparable cargo capacity are some of themost technologically advanced systems in existence. The enterprises that support thedesign, manufacture and distribution of these large aircraft are themselves complexglobal systems, with supply chains spanning multiple nations. The large commercialaviation industry has been seen as an area of “strategic trade” (Krugman 1986), making ita “critical part of the US industrial base in terms of skilled production jobs, appliedresearch, foreign exports, and inter-industry multiplier effects” (US International TradeCommission 2001), and the source of continuing international trade conflicts. Fiercecompetition in the large aircraft duopoly between Boeing and Airbus has led to theintroduction of new technologies and launch processes for aircraft, such as the newBoeing 787 Dreamliner which Boeing hopes will “change the rules” on how aircraft arelaunched (Pritchard and MacPherson 2004), and the restructuring of the Boeingenterprise around the concept of becoming a “systems integrator”, with the aim ofreducing costs and risks and speeding up the system development process (MacPhersonand Pritchard 2003). The ability to “change the rules” on aircraft is even more apparenton the Boeing conceptual Blended Wing Body (BWB) aircraft. With a more seamlessintegration of fuselage and wing structure, the BWB creates a new aircraft technicalarchitecture with improvements in multiple areas over the extant tube and wing technicalarchitecture. Together with the financial risks undertaken by the aircraft manufacturersoften “betting the firm” when a new aircraft is launched, the technological, enterprise andpolitical challenges create a complex system.1.1.2 GROUND TRANSPORTATION SYSTEMSGround transportation systems form the backbone of modern societies, providing themeans to move people and goods around cities and across and between countries. Withissues such as increasing traveler demand, congestion, safety, environment impact andsuburbanization, among others, the technical challenges involved in designing aneffective, efficient and sustainable transportation system have never been more difficult.The challenges involved with a transportation system go beyond the technical. Financing26

the large capital investment needed for infrastructure like railroads, airports, androadways poses a challenge even for the richest of nations. Political issues surroundingthe placement of large, intrusive infrastructure in one neighborhood versus another orchoosing one mode over another creates challenges in building coalitions of politicalsupport for any transportation solution. Social and cultural challenges associated withchanging demographics, land use changes and economic prosperity create changingnorms and expectations for transportation system usage and equity issues between richand poor. Taken together, these technical, economic, political, institutional, social, andcultural challenges create a complex system.The following section expands on the existence of uncertainty in complex systems andthe potential for flexibility as a means of coping with this uncertainty.1.1.3 UNCERTAINTY AND FLEXIBILITY IN COMPLEX SYSTEMSThe management of uncertainty is of particular importance in a complex system. This isbecause a complex system, more so than traditional engineering on a smaller scale,impacts more aspects of society and is longer lasting. This means that there are moresources from which uncertainty can arise and that the uncertainty can grow larger, due tolong time scales and multiple subsystems (de Neufville 2004).Uncertainty appears in many forms, such as technical uncertainty, economic uncertainty,scheduling uncertainty and political uncertainty. These areas have been recognized andtools have been developed in the past to deal with each. For example, factors of safetyare included in the technical design to accommodate technical uncertainty; managementreserves are created to address financial uncertainty; and work in major governmentprograms is spread over many congressional districts to reduce political uncertainty.Unfortunately, while these actions can be effective in reducing the uncertainty that istargeted, the system-wide uncertainty may not be significantly reduced. For example,including factors of safety may significantly increase economic costs which may increasethe uncertainty of political support in government programs. Or spreading the design andmanufacture over several political districts may decrease political uncertainty but canmake the management of the system more complex and may increase schedulinguncertainty. These “siloed” fixes for uncertainty can act to push the uncertainty from onepart of the system to another, rather than lower system-wide uncertainty. Solutions areneeded that reduce uncertainties across multiple dimensions.For this research, an emphasis is placed on examining flexible solutions to deal directlywith uncertainties stemming from future market demand and fuel prices in the BWB casestudy and travel demand and relative mode share in the ITS case study. The effect ofthese flexible solutions on other aspects of the system, such as political viability, or theeffect of system characteristics such as stakeholder fragmentation, are examined as wellin a more qualitative manner.27

  • Page 7 and 8: ACKNOWLEDGEMENTSThis dissertation i
  • Page 9: students. I am sure I am missing pe
  • Page 12 and 13: 6.7 Enterprise and Institutional Ch
  • Page 14 and 15: Table 8-8 Summary of existing mode
  • Page 16 and 17: Figure 3-17 System management loop
  • Page 18 and 19: Figure 5-13 Historical world annual
  • Page 20 and 21: Figure 7-19 Decision path for ITS m
  • Page 22 and 23: Figure 10-3 Summary of differences
  • Page 24 and 25: 1. A large commercial aircraft maki
  • Page 28 and 29: From the MIT Engineering Systems Di
  • Page 30 and 31: enterprise, the enterprise itself m
  • Page 32 and 33: system capable of coping with uncer
  • Page 34 and 35: Ch. 2Ch. 3Ch. 4Ch. 7Ch. 5Ch. 8Ch. 6
  • Page 36 and 37: applicability of the framework. Fin
  • Page 38 and 39: Myers, S. (1977) Determinants of Ca
  • Page 40 and 41: FindingsFigure 2-1 Research process
  • Page 42 and 43: • Difficult to predict future beh
  • Page 44 and 45: As is apparent in the literature, t
  • Page 46: of these. Ideally, either with the
  • Page 49 and 50: do not appear to be mutually exclus
  • Page 51 and 52: The ability for a system to activel
  • Page 53 and 54: price (the option price) for the fl
  • Page 55 and 56: and the results can be easier to ex
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  • Page 59 and 60: there is value to waiting to see wh
  • Page 61 and 62: 2.5 REAL OPTION PROCESSESExisting p
  • Page 63 and 64: option is then evaluated with a “
  • Page 65 and 66: • Option to engage in exploration
  • Page 67 and 68: elatively straight-forward and are
  • Page 69 and 70: OptionComplexityReal option in syst
  • Page 71 and 72: 2.8 REFERENCESAllen, T. et. al. (20
  • Page 73 and 74: Hayes, R. and D. Garvin. (1982) Man
  • Page 75 and 76: 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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    Enterprise Readiness is included as

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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

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    Additional benefits of the BWB arch

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    4.4.1 BWB OPTION DECISION PATHSFor

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    lower costs, higher scales of econo

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    Miller, B. (2005) A Generalized Rea

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    5 VALUE OF FLEXIBILITY IN BLENDED W

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    This chapter is composed of three m

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    this research were deemed necessary

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    For clarity of discussion, a high l

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    model, a better understanding of co

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    An overview of each of these subsys

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    important and may make inroads into

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    Figure 5-9 Airline finances and pro

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    Figure 5-10 Airline profitability,

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    Product design is based on a trade-

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    The airframe manufacturer productio

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    $70Inflation Adjusted Crude OilPric

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    5.2.5 MODEL VALIDATIONThe system dy

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    Forecast data (all planes)Model dat

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    5.3.1 INHERENT BENEFITSBWB technica

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    minor differences between aircraft

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    The remainder of this section looks

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    derivative depends on corporate str

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    Table 5-1 Number of derivatives lik

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    LowFuelCosts35%30%HighFuelCostsProb

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    The results presented can be interp

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    Compared to the Boeing 787, the dev

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    than a European option, because of

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    In the opposite case where the BWB

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    Because of the consequences of exer

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    35%30%Probability25%20%15%10%5%0%$-

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    BWB does not seem to offer advantag

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    type plane, relative to conventiona

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    5.4 REFERENCESAirbus. (2006) Annual

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    6 CHALLENGES OF FLEXIBILITY IN BLEN

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    FindingsFigure 6-1 Case study analy

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    Figure 6-2 Characteristics of case

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    6.1.3 INTERVIEWEE SELECTIONAs the i

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    Table 6-2 ITS case study organizati

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    about flexibility, i.e. is it a goo

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    2. If flexibility is used, can you

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    case with BCA, which has embraced a

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    primarily through military and NASA

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    Figure 6-7 Delivery and market fore

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    to meet rising demand, the overall

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    Another option widespread in the ai

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    design, evaluate or manage flexibil

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    Interviewee views on flexibility ce

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    and evaluations are based around th

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    operating and maintenance costs by

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    when fuel costs increased substanti

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    options, such as cross-program deri

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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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    operating conditions. Additional ro

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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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    BuildtraditionalinfrastructureDelay

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    HOT / BRTlaneNon-flexibleTOT / BRTl

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    BuildtraditionalinfrastructureDelay

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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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    met with business interests before

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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

  • Page 465:

    10.7 REFERENCESClemons, E. and B. G

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