Valuing Real Options for Network Investment Decisions and Cost-Based Access Pricing

Abstract

In this article, we propose a model and methodology for valuing the option to delay network investment decisions and calculating cost-based access prices. We model the value of the option to invest in each network element as a function of two stochastic variables: the flow of total variable profit from the service provided by the network element and the cost of new investment in that network element. We calculate the option value multiple to be applied to the investment cost component of three main network elements, conduct sensitivity analyses, and highlight key findings.

Acknowledgments

The authors thank Marco Antonio Guimarães Dias, professor of Industrial Engineering at Pontifícia Universidade Católica, Rio de Janeiro, Brazil, for helpful suggestions and discussions on real options theory and practice.