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"Complex" Real Options - Title Page - MIT

"Complex" Real Options - Title Page - MIT

there are not as many

there are not as many basic options to choose from, compared to financial options wherebasic call and put options can be built on to create more advanced options. For example,in financial options, much time and effort is devoted to creating exotic options asinvestment vehicles for specific needs. These exotic options, such as butterfly or collaroptions (Hull 2002), are created from basic call and put options. These exotic optionsserve additional investment purposes and can be created without having to recreate thebasic set of options, providing a fundamental set of well understood option “buildingblocks”, with which to work. These building blocks may not be present for “complex”real options in complex system.3.1.2.1.2 Ability to Conceive Real Option at the Enterprise and Institutional LevelOptions are instruments that can not exist in a vacuum. Rather, they require a substantialamount of supporting infrastructure, from the existence of basic institutions to theexistence of proper incentives.In the case of financial options, multiple institutions are present. At a basic level, theexistence of a market system is needed on which to trade the option itself and the option’sunderlying asset, such as stocks on a stock market. Other related infrastructure is presentas well, such as stock brokerages, which facilitate easy transactions between optionsellers and option buyers. Additionally, the existence of supporting institutions andorganizations, such as legal courts and the Securities Exchange Commission help enforceoption contracts and ensure that the market and the options are not being manipulatedunfairly.For real options the supporting institutions may be different than for financial options. Ata minimum, supporting institutions are needed to allow the design, purchase and exerciseof options. If the supporting institutions do not support these activities, then it is unlikelythat flexibility in systems is feasible. The complete set of supporting institutions neededfor flexibility in systems is not known. But at a minimum, supporting institutions that donot forbid flexibility and incentivize people to make use of flexibility are needed.Public institutions are a good example of an institutional architecture that may forbidflexibility in systems. To exercise an option, program managers would need the ability tomake a system change, such as expanding, contracting, starting, or terminating aprogram. However, funding, by law, can only be used in the manner that it wasappropriated. Without prior approval, it may be illegal for the system to be changed ascalled for when exercising options.Many common incentive structures in place in private enterprises are also not alignedwith using some types of flexibility. For example, the flexibility to contract or terminatea program could have value for the enterprise. However, the incentives for a managermay not be aligned with options to terminate or reduce a program, as early programtermination could be interpreted as a failure and negatively affect the manager’s career.86

3.1.2.2 Design and Evaluation of OptionsThe design and evaluation of “standard” real options is more challenging than financialoptions. And the design and evaluation of “complex” real options in complex systems,shown in Figure 3-6, is more challenging than for “standard” real options. For“complex” real options in complex systems, the difficulty posed by the physical system,the social system or the interaction between the two can create barriers to the design andanalysis of the system. The challenges may be daunting enough so that even if a“complex” real option in a complex system is designed, no tools are available toadequately analyze it. This could result in either the option being purchased withoutmore than a qualitative sense of its value, or it could result in the option not beingpurchased because no quantitative analysis could be conducted to justify the investment.Monitor/ManageFigure 3-6 Design and evaluation of options.3.1.2.3 Purchasing and Managing an OptionThe difference between “complex” real options in complex systems and financial optionsare evident in the purchasing and management phases. The ability to purchase andmanaged a financial option is typically a straight-forward activity. A pre-existing optionis identified, or an option is created, then priced and sold. The terms of the option arewell known and agreed upon, such as the sale price, the identities of the option seller andowner, the terms of the sale and the rights granted to the new option holder. Typically,once the option is sold, the former option owner has no further control over the option orthe new option holder. Further, the stakeholder who purchases the option is the samestakeholder who manages the option, or at least there is alignment between the interestsof the option purchaser, the option owner and the option manager – i.e. the stakeholderwho determines if and when the option should be exercised.Monitor/ManageFigure 3-7 Purchase and management of option.87

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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

  • 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
  • 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 and 82: Figure 3-3 Condensed version of the
  • Page 83 and 84: level, the appropriate enterprise n
  • Page 85: 3.1.2.1 Conceiving an OptionThe abi
  • 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
  • Page 131 and 132: The 1950’s saw aircraft shift fro
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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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