Real Option-Based decision model for fuel saving devices in transportation vehicles under flexible design

Abstract

Operations that depend on transportation vehicles experience a high degree of uncertainty in fuel costs. We construct and analyze the engineering economic problem of how to value flexibility when the vehicle design under consideration enables fuel savings in the future by incurring an initial cost for the vehicle to incorporate features that will support future modifications. For a vehicle manufacturer working with a customer, we derive the optimal threshold fuel costs to incorporate such features and to decommission under the net benefit maximization through a real options approach. From these derivations as well as an illustrative example in the case of winglets for aircraft, we present the managerial insights and economic implications of the flexible design in transportation vehicles.

Acknowledgments

The authors would much like to thank the Editor in Chief, the Former Editor in Chief, the Area Editor, two anonymous referees, and Dr. Gul Kremer for all the constructive and developmental comments throughout the long review process. The first author also would like to thank Zhuoyi Zhao and Farshad Niayeshpour for various aspects of data collection as well as validation efforts.

Additional information

Funding

The authors also would like to note that this material is based upon work supported by the Slater Fellowship for Sustainable Design and Manufacturing, National Science Foundation under Grant Numbers' CNS 1238335, DUE 1504912, and EEC 1460984.

Notes on contributors

K. Jo Min

K. Jo Min received a B.S. degree in mathematics systems science from the University of California, Los Angeles, and an M.S. and Ph.D. in industrial engineering and operations research from the University of California, Berkeley. He is currently John B. Slater Fellow of Sustainable Design and Manufacturing, Director of Undergraduate Education, and Associate Professor in the Department of Industrial and Manufacturing Systems Engineering, Iowa State University. His research interest focuses on economic modeling and analysis of energy and material systems such as generation planning for renewable energy and closed-loop supply chains.

John Jackman

John Jackman is Associate Professor in the Department of Industrial and Manufacturing Systems Engineering, Iowa State University. He is currently on leave to National Science Foundation and serves as a program director in the Division of Undergraduate Education.

His current research interests are: Engineering education, uncertainty in systems, incomplete information, computational models, and system behavior prediction.