Investment Valuation of Underground Freight Transportation Systems under Uncertainty

Abstract

Investment valuation of underground freight transportation (UFT) systems is subject to a high level of uncertainties, including construction cost fluctuations and shipment revenue variations. Real options analysis is known as a promising approach for investment valuation of transportation projects under uncertainty. However, the extant real options approaches are theoretically deficient to appropriately model the UFT uncertainties with heterogeneous stochastic behaviors. While fluctuations in the construction cost of transportation projects typically follow the geometric Brownian motion (GBM) process, freight rate variation is a mean-reverting process. For the first time, a bivariate real options model is developed for investment valuation of UFT systems considering both these underlying uncertainties. A calibration approach is established to customize the model for capturing both GBM and mean-reverting attributes of the uncertainties. Also, a dynamic programming approach is adopted to identify the optimal time to invest in a UFT system. Finally, an illustrative case example is used to show the step-by-step implementation of the proposed model. Although the net present value (NPV) analysis showed this UFT case example is not financially viable, the proposed real options model demonstrated that this investment becomes quite promising if future contingent outcomes and the value of decision-making flexibilities are taken into account. The proposed model provides transportation capital planners with an optimal policy scheme that offers a timeline for viable investment in UFT systems. The presented model can also be used for investment valuation of other transportation development projects that involve two uncertainties with GBM and mean-reverting stochastic characteristics.