Joint Venture Valuation: Using Real Options And Monte Carlo Simulation

With the development of globalization, joint ventures have been playing an important role in China’s economy. Therefore, joint venture valuation, as well as the management strategies have been one of the most significant research topics in both management and finance.However, existing enterprise valuation methods are not completely applicable to joint ventures. For one thing, traditional valuation methods e.g. Discounted Cash Flow and Net Present Value are based on strict assumptions of the product market. For another, existing valuation methods disregard the value of management strategies. In fact, taking joint ventures as options of parent companies, real option theory can therefore be applied to the valuation process. With the purpose of constructing a valuation model for joint ventures, we use real option theory and Monte Carlo simulation on the valuation process and investment strategies from the perspective of joint venture managers. Also, we apply partial equilibrium analysis to investigate the impact of key variables in the external market and internal management on the valuation.The results of our simulation show that the valuation is negatively correlated with exogenous market volatilities. The value of joint venture is positively correlated with the correlation of cost between the parents. Moreover, managers tend to make the investment decision under the case of small exogenous market volatilities, large producing synergy, and equal equity distribution. On the other hand, there would be no linear relationship between the expected marginal cost and the joint venture value under the situation of different expected marginal costs among parentsThe application of real option theory and Monte Carlo Simulation to joint venture valuation has theoretical and methodological values. For one thing, the simulation results are in the line with most of previous research, which verifies that real option theory can be applied to joint venture valuation, as well as managers’decision making process. Starting from the view of joint venture managers, our model provides a new way to evaluate investment strategies. For another, Monte Carlo simulation is used in the valuation process, which helps to solve the dimension of disaster in polynomial processes of option pricing, and provides a more efficient method for joint venture valuation in the long term.