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Investing in Perennial Pasture Improvement: A Real Options Analysis
Author(s) -
Tozer Peter R.,
Stokes Jeffrey R.
Publication year - 2009
Publication title -
applied economic perspectives and policy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.4
H-Index - 49
eISSN - 2040-5804
pISSN - 2040-5790
DOI - 10.1111/j.1467-9353.2008.01427.x
Subject(s) - perennial plant , pasture , business , economics , natural resource economics , agricultural economics , geography , forestry , agronomy , biology
In investment analysis, uncertainty and irreversibility can undermine net present value (NPV) as a decision rule since the option to delay investment may have value. We apply the real option theory of investment to the pasture investment decision facing livestock producers in southwest Western Australia. In 2006, livestock producers thinned their herds as pasture availability dwindled due to extreme drought conditions. This left producers with a unique opportunity to either establish new perennial pastures for their cattle or utilize volunteer annual pasture and invest in more sheep breeders. In either case, large and irreversible investments fraught with multiple sources of uncertainty implies that one can gain useful insights by casting the investment problem in a real option context. The results suggest that required rates of return for each investment alternative are about 1% to 1.5% higher than standard NPV would suggest with sheep production having the lower required rate of return.