Robustness and Real Options for Vehicle Design and Investment Decisions Under Gas Price and Regulatory Uncertainties

Abstract

Manufacturers must decide when to invest and launch a new vehicle segment or how to redesign vehicles existing segment under market uncertainties. We present an optimization framework for redesigning or investing in future vehicles using real options to address uncertainty in gas price and regulatory standards like the U.S. Corporate Average Fuel Economy (CAFE) standard. In a specific study involving a product of gasoline, hybrid electric, and electric vehicles (EV), we examine the relationship between gas price and CAFE uncertainties to support decisions by manufacturers on product mix and by policy makers on proposing standards. A real options model is used for the time delay on investment, redesign, and pricing, integrated with a robust design formulation to optimize expected net present value (ENPV) and net present value (NPV) robustness. Results for nine different scenarios suggest that policy makers should consider gas price when setting CAFE standards; and manufacturers should consider the trade-off between ENPV and robust NPVs. Results also suggest that change of product mix rather than vehicle redesign better addresses CAFE standards inflation.