Investment appraisal under uncertainty - A fuzzy real options approach

Abstract

The main purpose of this paper is to propose a fuzzy approach for investment project valuation in uncertain environments from the aspect of real options. The traditional approaches to project valuation are based on discounted cash flows (DCF) analysis which provides measures like net present value (NPV) and internal rate of return (IRR). However, DCF-based approaches exhibit two major pitfalls. One is that DCF parameters such as cash flows cannot be estimated precisely in the uncertain decision making environments. The other one is that the values of managerial flexibilities in investment projects cannot be exactly revealed through DCF analysis. Both of them would entail improper results on strategic investment projects valuation. Therefore, this paper proposes a fuzzy binomial approach that can be used in project valuation under uncertainty. The proposed approach also reveals the value of flexibilities embedded in the project. Furthermore, this paper provides a method to compute the mean value of a project's fuzzy expanded NPV that represents the entire value of project. Finally, we use the approach to practically evaluate a project. © 2010 Springer-Verlag.