EVALUATING POTENTIAL INVESTMENTS IN THE PINK LADY APPLE CULTIVAR UNDER UNCERTAINTY AND IRREVERSIBILITY

Abstract

Many South African (SA) apple producers are currently considering whether or not to invest in the Pink Lady apple cultivar in response to the changing tastes of international fresh apple consumers. Given uncertainty about Pink Lady apple yields, costs and prices, and that orchard investment costs are irreversible (cannot be fully recovered in the short term), an ex ante version of the Dixit-Pindyck investment model is used to assess the viability of such an investment under uncertainty and irreversibility. This model accounts for uncertainty and irreversibility by raising the orthodox hurdle rate that must be met to justify the orchard investment by an amount that reflects the value of the option to postpone the investment. The results suggest that SA apple producers should only invest in a Pink Lady apple orchard with a 35-year lifespan if the expected annual real rate-of-return is above 10.75%, which is more than double the orthodox real rate of five per cent that is commonly used in capital budgeting analyses. Differences of this level between orthodox and modified hurdle rates have also been reported in recent studies of the adoption of dairy housing technology, and investment in grapefruit orchards, in the United States.