Capital renewal as a real option

M.J. Reindorp, M.C. Fu

Research output: Contribution to journalArticleAcademicpeer-review

9 Citations (Scopus)
3 Downloads (Pure)

Abstract

We consider the timing of replacement of obsolete subsystems within an extensive, complex infrastructure. Such replacement action, known as capital renewal, must balance uncertainty about future profitability against uncertainty about future renewal costs. Treating renewal investments as real options, we derive an optimal solution to the infinite horizon version of this problem and determine the total present value of an institution’s capital renewal options. We investigate the sensitivity of the infinite horizon solution to variations in key problem parameters and highlight the system scenarios in which timely renewal activity is most profitable. For finite horizon renewal planning, we show that our solution performs better than a policy of constant periodic renewals if more than two renewal cycles are completed.
Original languageEnglish
Pages (from-to)109-117
Number of pages9
JournalEuropean Journal of Operational Research
Volume1
Issue number214
DOIs
Publication statusPublished - 2011

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