Project is to develop analytical framework for decision

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Reference no: EM132195582

The purpose of this project is to develop an analytical framework for decision-making under uncertainty. More specifically, assume that a firm is contemplating investment in a project, e.g. a power plant, facing price uncertainty. The project has the following characteristics:

1. There is a variable operating cost, c in £/unit. Hence, if the project has installed capacity Q, then the operating cost per unit of time is cQ.

2. There is an investment cost, I in £ that depends on the size of the project, denoted by Q. The investment cost function can be expressed as I(Q) = aQb , where a and b are positive constants.

3. The output price, Pt , is stochastic and follows a geometric Brownian motion, which is indicated below.

dPt = µPtdt + ?PtdZt , P0 ? P > 0

4.The firm can choose not only the time of investment but also the size of the project.

5. The project has operational flexibility, i.e., the firm can abandon the project.

The objective is to determine the optimal investment policy and analyse how it is affected by different forms of managerial discretion. More specifically, how is the decision to invest affected by the firm’s option to abandon operations or choose the size of the project? Apply a variety of more advanced OR methods, e.g. dynamic programming

Since the project has an operating cost c, it may be optimal to terminate it at some point if the price drops below c. Hence, in a different subsection, you should introduce operational flexibility in the form of an embedded abandonment option. The objetive is to determine how this option impacts the firm's decision to invest.

Reference no: EM132195582

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