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"Complex" Real Options - Title Page - MIT

"Complex" Real Options - Title Page - MIT

Framework. The second

Framework. The second perspective in the following section is a discussion of the sixidentified phases in an option’s life-cycle.3.1.1 FIVE DRIVERS IN LCFUncertainty surrounding future conditions is the reason that flexibility may be needed ina system. In “standard” real options, relatively simple changes are made to the system tocreate the flexibility. And in “standard” real option analysis processes, relativelystraightforward techniques are used to evaluate the option value. However, for“complex” real options in complex systems, additional considerations may need to betaken into account if the option is to provide the intended value. These considerationsacted as drivers, or critical considerations that were taken into account when the LCFFramework was constructed. The drivers that were explicitly identified are as follows:1. The presence of uncertainty surrounding future system needs and performance.2. The need for enterprise and institutional architectures that enable the ability todesign and/or exercise an option that has been designed into the system to addresstechnical uncertainty3. The need to take into account transaction costs that increase the total costsassociated with the option. Transaction costs may encompass more thaneconomic costs, such as the expenditure of political capital in the exercise ofoptions4. The need for the ability to monitor the system so that the current state of thesystem is known well enough to make a decision regarding when or if an optionshould be exercised5. The recognition and ability to cope with sources of uncertainty that are unknownat time = 0, called unknown unknownsThese five drivers are discussed in more detail below.Technical uncertainty – The first driver, technical uncertainty, is of the typetraditionally looked at in the real options literature. The initial process involved indesigning and evaluating options that deal with technical uncertainty are no differentbetween “standard” real option processes and the LCF Framework. However, as theoptions of interest may not be “standard” real options, but are instead “complex” realoptions in complex systems, additional design and evaluation machinery is built into theLCF Framework, compared to “standard” real options processes.Enterprise and institutional architectures – An enterprise with the desire to create aflexible system needs to have the ability to conceive, design, analyze, implement and thenpotentially exercise a flexible system. The enterprise must have an architecture that notonly facilities the ability to conceive and design the flexible system, but also the ability toactively manage the flexibility that has been designed in the system.For public enterprises interested in flexibility, both enterprise and institutionalarchitecture considerations need to be addressed. At the institutional, or “rule making”,82

level, the appropriate enterprise needs to have been vested with the legal authority fordesigning, evaluating and managing a flexible system. The need for an appropriateinstitutional architecture is applicable more to public, rather than private, enterprises.This is because public enterprises have to cope with the additional constraint of operatingas a government agency.Transaction costs – In the real options literature, the cost typically associated with theuse of flexibility has been the direct cost of adding flexibility to the system, or in optionparlance, the option cost. The exercise cost, or additional cost needed to change the stateof the system by exercising the option, is also considered in the realm of real optionsliterature. Not considered are additional transaction costs associated with purchasing orexercising the option. For financial options, these transaction costs can include monetarycosts such as broker fees, but can also include other costs such as the time andinformation costs associated with finding a broker and ensuring that they are reputable.For “complex” real options in complex systems, given the potential large scope of thetechnical system and the number of stakeholders involved in some manner with theoption during its life-cycle, it seems evident that the transaction costs may not benegligible. Rather, these transaction costs may have a cost that are significant, or on thesame order of magnitude as the option purchase and exercise costs, and therefore shouldbe explicitly considered.Monitoring the system – Unlike financial options, where the information on movementof an underlying asset is continuously collected, reported and easily obtainable, the samemay not be true for real options. Information is needed to make the determination ofwhen or if to exercise an option. Being able to identify the appropriate information thatneeds to be collected, and then collect, analyze, disseminate and act on the information ina timely manner is non-trivial.Unknown unknowns – The real options literature dealing with flexibility hasconcentrated on uncertainties that can be identified a priori, specifically statisticallycharacterized phenomena. As shown previously in Figure 2-3, these types ofuncertainties are but one type that can be encountered. It is assumed here that the knownunknown variety of uncertainty can, with effort or assumptions, be analyzed in a similarmanner to the statistically characterized phenomena type of uncertainty.However, unknown unknowns are assumed to require a completely different copingstrategy. As unknown unknowns are by definition not known, and therefore notconsidered, during the design process, it is unclear if it is possible to systematically andpurposefully (rather than by luck) design flexibility in a physical system to addressunknown unknowns.Rather, it would seem that unknown unknown uncertainties create the need to designflexibility in the enterprise or institutional architectures, rather than the physical system.A flexible enterprise or institutional architecture could allow for a faster change instandard operating procedures to allow the enterprise or institution to adapt to theunexpected circumstances affecting the system.83

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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

  • 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
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  • Page 53 and 54: price (the option price) for the fl
  • Page 55 and 56: and the results can be easier to ex
  • Page 57 and 58: For some real options this appears
  • 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
  • Page 77 and 78: 3 LIFE-CYCLE FLEXIBILITY (LCF) FRAM
  • Page 79 and 80: 3.1 OVERVIEW OF NEED FOR LIFE-CYCLE
  • Page 81: Figure 3-3 Condensed version of the
  • Page 85 and 86: 3.1.2.1 Conceiving an OptionThe abi
  • Page 87 and 88: 3.1.2.2 Design and Evaluation of Op
  • Page 89 and 90: option holder can not exercise the
  • Page 91 and 92: system’s underlying structure and
  • Page 93 and 94: 3.2.2 DECISION TO USE LCF FRAMEWORK
  • Page 95 and 96: Figure 3-11 Integration of decision
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  • Page 99 and 100: quantitative analysis chapters, Sec
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  • Page 105 and 106: anticipated that external political
  • Page 107 and 108: Figure 3-16 illustrates how the str
  • Page 109 and 110: 3.2.6 MANAGING THE SYSTEMManaging t
  • Page 111 and 112: System Management LoopFigure 3-17 S
  • Page 113 and 114: System Management LoopSystemImpleme
  • Page 115 and 116: Long-term Management Loop ofUnknown
  • Page 117 and 118: Long-term Management Loop of Unknow
  • Page 119 and 120: Enterprise Readiness is included as
  • Page 121 and 122: Figure 3-23 Condensed LCF Framework
  • Page 123 and 124: 3.4 REFERENCESAllen, T. et. al. (20
  • Page 125 and 126: 4 FLEXIBILITY IN BLENDED WING BODY
  • Page 127 and 128: 4.1.1 THE EARLY YEARSAfter the firs
  • Page 129 and 130: Figure 4-2 Sikorsky S-42 Flying Boa
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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

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    10.7 REFERENCESClemons, E. and B. G

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