| This thesis evaluates the profitability of a proposed investment in a poultry litter processing plant that would convert poultry litter into electricity. Such an investment would help resolve a serious environmental issue and, if profitable, provide poultry producers an additional source of income.;Typical tools for evaluating potential investments, such as net present value, are appropriate for investments with predictable returns. Evaluations of investments with significant risk, though, must use different tools to fully consider the effects of risk.;This thesis used real options to evaluate the investment. When there is uncertainty about future cash flows a real option approach can provide additional information that models such as Net Present Value (NPV) cannot. It can help a firm understand and value the flexibility it has before it actually makes the investment.;A real option values the potential investor's flexibility in choosing to invest now, wait until a later date to invest, or to not invest at all, explicitly considering the time value of that flexibility. A key advantage of a real option valuation over NPV analysis is that a real option explicitly considers the probability that under certain events or contingencies an investment that has negative NPV might become valuable, and puts a value on that probability.;NPV analysis using estimates from the firm's business plan of the proposed plant's operating efficiency and capacity utilization indicated the investment should be made. Risk analysis using RISK software provided a distribution of net income, given the variability of random inputs affecting net income such as prices of inputs and outputs, operating capacity utilization, and process efficiency. The real option analysis puts a dollar value on that risk. It indicated that there is time value in the investment so waiting to invest could increase the value of the investment.;When lower operating efficiency and capacity utilization were assumed, NPV became negative, indicating that the investment should not be made. However, the real option analysis indicated that there is value in owning an option to invest, because there is a probability that the investment will actually become valuable and generate a positive NPV. |
