Date of Graduation

1996

Document Type

Dissertation/Thesis

Abstract

Discounted cash flow analysis (DCF) is the most common evaluation method used to evaluate capital investment. However, this method is static in nature and does not recognize the existence of managerial flexibility. An evaluation method that recognizes managerial flexibility is desired and may be obtained by the development of an investment and operational simulation coupled with an expert system. An investment simulation was developed using a gold mine as an example with stochastic output price and a combination of conventional cash flow analysis and an expert system. Actual gold prices from 1973 to 1984 were used as the historical data base in the simulation, and from 1985 to 1994 to test the behavior of the simulation. The simulated investment could take place any time from 1985 to 1994. Investment and operation decision rules were formulated and incorporated into a simulation and expert system to model the important investment and operation features of a real investment opportunity. The simulation was based on decision rules and net present value (NPV) resulting from forecasts of gold prices and operating cost. Costs included initial investment, shut-down, care and maintenance, reopening and abandonment as well as operating cost. Results of the simulation were analyzed using Monte Carlo sampling to determine the probabilistic values of NPV. Option pricing method and conventional NPV were compared to the NPV obtained through the simulation. The results of this study showed that the simulation performed better than simple DCF analysis on the grounds that: (1) it resulted in a lower coefficient of variation in the expected NPV; (2) it diversified a portion of market risk by recognizing the value of operational flexibility; (3) it quantified the increment of market risk captured through operational flexibility; and (4) it recognized the effects active management may have on the value of a project.

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