Neal Lewis

Real Options and Real Engineering Projects

Abstract: Real options analysis is a tool that has not fully justified itself in the face of real world complexity. It is intended to value flexibility in future choices; however, much of the literature focuses on the mathematical details of how to perform real options analyses, without taking the time to ask whether key characteristics of engineering projects have been properly recognized. In addition, many papers contrast real options analysis with a simple NPV analysis with deterministic data and no options. Because engineering economic analysis has long included decision trees, sensitivity analysis, simulation and other tools, the key question is, what does real options analysis add to this toolbox? A comparison of real and financial options and case studies of engineering projects led us to conclude that the value of real options is more limited than many suggest. Different recommendations due to the use of real options may be limited to near-zero NPV projects where the future benefit stream can be well forecasted and where uncertainty can be identified. This can lead to great difficulty in applying options to real engineering projects.

Valuation for the Strategic Management of Research and Development Projects: The Deferral Option

Abstract: The most widely used financial technique for evaluating projects is discounted cash flow; however, discounted cash flow analysis fails to consider flexibility. Real options analysis offers an alternative technique that provides value for the managerial flexibility that is inherent in most R&D projects. This article investigates the deferral option using computer simulation. There are five variables that determine the value of the deferral option, and simulations analyze these variables over a wide range of conditions. Sensitivity analysis on the five variables is performed and the results are discussed.

Technical Note: Waiting Cost Models for Real Options

When real options are used to estimate the value of delaying an engineering project, it is necessary to consider the cash flows or project benefits that are lost due to the delay. This note describes various models of these cash flows and surveys previous TEE articles to see which are used and how often delay costs are ignored. The first model considered is based on the lost dividends Black-Scholes model for financial options, which is one of the most common models used in real options even though it does not explicitly consider cash flows. More realistic scenarios include the loss of initial cash flows, delays in starting to receive the same number of cash flows, loss of cash flows at the project horizon, and permanent loss of market share. The outcomes are compared with the often unrealistic case of omitting these delay costs. We assert that the common omission of waiting costs is rarely appropriate and offer models that better capture the costs of delaying real projects.

An evaluative economic development typology for sustainable rural economic development

This research develops a management typology that focuses on the importance of project typology and selection as part of sustainable rural economic development. The typology includes quality of life elements, the overall community resource base, and the capacity to generate projects. It considers various implications on the social, economic, and environmental factors at a very early stage in the project life cycle. The typology also develops selection criteria for rural economic projects that include a strong risk assessment phase. Data collected from two rural economic projects are used to examine strategic planning and project selection processes. Results may be used to develop effective strategies to stimulate rural economies.

A Content Analysis of Data Collection and Analysis Techniques as Reported in the Engineering Management Literature

Abstract: Engineering management involves an extremely diverse range of topics, problems, and questions, many of which involve both human and non-human elements. An analysis of the methods used in the field of engineering management is important in order to identify trends in the use of methods, to promote the training of future research practitioners, and to build overall knowledge for and about change. This article reviews the studies reported in journals relevant to engineering management and describes and categorizes the data collection and analysis methods, reporting relative frequencies and trends in the use of these methods.

Breakeven Volatility for Real Option Valuation

Abstract: Financial and real options values depend on several variables, including the volatility parameter. Real option volatility arises from the uncertainty of forecasts, and thus, is more subjective than financial option volatility. Difficulties in estimating the volatility parameter inhibit confidence in the resulting option value. This article reviews current estimation methods and proposes a reverse methodology. Real options analysis determines an option value which, combined with project NPV, creates an Expanded Net Present Value (ENPV) such that ENPV exceeding zero justifies a project. At breakeven (ENPV = 0), the minimum option value that justifies the project equals NPV. This breakeven option value determines an implied breakeven volatility.

Determining When Simplified Agile Project Management Is Right for Small Teams

Abstract: Agile project management was developed in the information technology industry as a way of increasing efficiency, productivity, and responsiveness to customers. Many projects with highly uncertain scopes, tasks, task precedence relationships, and/or resources are difficult to handle with traditional planning tools. Better planning in such cases does not lead to better outcomes. An agile approach that maximizes productivity and quality within the resource and time constraints can be superior whether or not the project is IT related. This article addresses when a simplified agile project management methodology can be appropriate for small teams both in academia and in industry.

The Roles of Tabulated Factors, Financial Calculators, and Spreadsheets in Engineering Economy Teaching

For decades engineering economists have discussed the balance between using tabulated engineering economy factors and spreadsheets for the first course in engineering economy. However, the potential role of financially capable calculators has been ignored. Many engineering economy faculty personally use a financial calculator for time value of money (TVM) calculations, but judging from engineering economy texts and past discussions at conferences there is little or no use of such calculators by students. Such calculators allow us the opportunity to phase out the tables and reduce the fraction of our courses that is spent on financial arithmetic. Students should be able to use tables, calculators, and spreadsheets, but our courses and their preparation for professional practice can be improved by minimizing the amount of time spent using tabulated factors.