Valuing Maritime Investments With Real Options

The nature of the global economy is one of dynamic change, subject to a great number of variables. Shipping, being a service industry, is affected by changes in international trade levels and patterns, following through to the whole maritime industry. This provides significant challenges to operators, builders, naval architects and marine engineers as they navigate unpredictable demand changes in the economic environment. Not only may shipowners be faced with the dynamics of boom-and-bust environments affecting strategic planning investment decisions, but they also need to weather unexpected events such as financial crises and pandemics. With a drive to a new greener world, owners are faced also with decisions as to technology and/or fuel choice, each involving high risk factors. The more uncertainty (risk) present, the greater will be the value of the embedded real options (strategies). Standard (passive) capital budgeting analysis has limitations and is only suitable in a world of certainty as the technique cannot incorporate explicitly the flexibility to respond to new information or appropriate strategic response. Investment evaluation using real option analysis (ROA), however, does provides a means to incorporate flexibility in the valuation process. Flexibility is valued like a financial option using non-arbitrage and added to present value of the original (passive) strategy to derive the present value of the flexible strategy. The power of the technique is explained by discussing examples of how ROA, by explicitly valuing various embedded options, is the appropriate tool to determine a more accurate valuation of investments. Two case studies illustrated the efficacy of the ROA over static net present value (NPV) in a dynamic world environment and an appropriate “course to chart” for the maritime industry.