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A Real Options Approach for the Investment Decisions of a Farm‐Based Anaerobic Digester
Author(s) -
Anderson Robert C.,
Weersink Alfons
Publication year - 2014
Publication title -
canadian journal of agricultural economics/revue canadienne d'agroeconomie
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 37
eISSN - 1744-7976
pISSN - 0008-3976
DOI - 10.1111/cjag.12019
Subject(s) - net present value , profitability index , present value , option value , revenue , investment (military) , business , economics , sunk costs , value (mathematics) , agricultural science , finance , agricultural economics , microeconomics , production (economics) , environmental science , machine learning , politics , political science , computer science , law
The profitability of anaerobic digesters (ADs) for Ontario dairy farmers are examined using real options under current and proposed government pricing policies and investment uncertainty. In the case of a renewable energy initiative such as an AD with large sunk costs and volatile returns, the value of deferring investment may be significant enough to offset the returns suggested by the net present value (NPV) approach. For a 150 cow herd, net revenues should be approximately $1.1 million before the AD is installed using the real options approach as compared to $0.5 million with the NPV approach. An AD is close to generating a positive NPV for a 600 cow herd if for either a 1% increase in the electrical price or decrease in the cost. However, farmers need not invest today and there is a value to delaying this decision from potential improvements in the technology that increase the efficiency and/or decrease operating costs of the AD. The real options analysis indicates that this option to delay investment has a value of approximately $300,000 for a typical Ontario dairy farm. Thus, either significant grant funding or higher feed‐in‐tariff rates are required to induce the increased adoption of AD technology in Ontario today even for the largest of dairy farms. Considering the probability of government support potentially ending, increases the value of investing today but a significant option value to defer still exists.