Identification of Real Options “in” Projects

The concept of real options initiated in the field of finance has extended into engineering systems to model design flexibility in the realistically uncertain environment. However, whereas financial options are well-defined traded contracts, real options “in” engineering systems are a priori undefined, complex, and interdependent. Moreover, systems involve many more options than designers could consider. Therefore designers need to identify the real options most likely to offer good flexibility and the most value. This paper proposes a procedure to identify real options “in” engineering systems. It consists of a screening and a simulation model. The screening model is a simplified, conceptual, low-fidelity representation of the system that reflects its most important issues. As it is inexpensive to run, it is used to test extensively designs under dynamic conditions. The following simulation model is used to validate critical considerations, such as the robustness and reliability of the designs, which are omitted from the screening model in order to expedite its operation. The paper first establishes the concepts of the options identification model, and then resorts to examples to detail its application. The case of a hydro power system formulates the screening and simulation models, and presents the specific steps needed to search systematically for the interesting real options.