Appraisal of shipping investment projects using real options

Abstract

This chapter intends to describe the use of real options in shipping providing simple practical examples. Shipping companies operate in a highly volatile market where their investment decisions are of vital importance. The main advantage of real options analysis (ROA) over the discount cash flows (DCF) methods is that it can properly capture the managerial flexibility related to an investment. A question that arises at this point is why investment analysts in the shipping industry should use ROA to assess their investment since real options seem at first sight more complicated than the simpler DCF methods. The chapter explains the real options analysis in a simple way. It also explains the superior position of ROA relative to alternative capital budgeting techniques. The chapter briefly describes the main real options in shipping industry which are the option to expand, the option to defer, the option to abandon, the option to contract, the option to switch, and growth options.