NEWS RELEASE: Pace University researcher develops new model for valuing hydro-electric power investment in emerging and developing markets

Richard E. Ottoo, PhD, a finance professor at Pace University’s Lubin School of Business, has developed a new contingency-claims model for valuing hydro-electric power investment under uncertainty and conditions typical of emerging and developing market settings.

 

 

FOR IMMEDIATE RELEASE

Pace University researcher develops new model for valuing hydro-electric power investment in emerging and developing markets

NEW YORK, NY – April 3, 2012 – Richard E. Ottoo, PhD, a finance professor at Pace University’s Lubin School of Business, has developed a new contingency-claims model for valuing hydro-electric power investment under uncertainty and conditions typical of emerging and developing market settings.

The new study focuses on alternative energy development and financing and offers many innovative contributions to the field of investment valuation in emerging markets.

Analyzing the volatility of rainfall around the main source of the Nile River to proxy for climate risk, Ottoo presents a real options technique to value a hydro-electric power project that the government of Uganda seeks to undertake in partnership with a competitive international investor.

The study shows that the incorporation of real options reduces the magnitude of required debt finance, which is a favorable balancing condition for a sponsoring government.

The study demonstrates measurement of the investment’s cost of capital which is shown to also include risk premiums for the project’s lack of liquidity, the country’s lack of transparency, and the economy’s low degree of integration with the global capital markets.

“The sole application of discounted cash flow method of valuation is found to significantly undervalue the project and may erroneously lead to rejecting or mis-timing the investment,” Ottoo writes. “Exclusive use of either debt or equity capital is not optimal.”

The study investigates and values the hydro power project by analyzing the effects of risks and contingencies and determines the optimal decisions to invest, finance and operate the venture. Ottoo identifies sources of uncertainty and incorporates five key factors in the value creation process:

(a)        Market Opportunity: The size of the electricity market is driven mainly by the demand and the market price for electricity and is measured by forecasting the project’s operating cash flows.

(b)        Capital Investment: Required financing for the project and its magnitude is critical in determining the decision to either invest or not. Ottoo assumes that capital expenditures, in the form of a mix of debt and equity, are uncorrelated with the present value of the operating cash flows.

(c)        Natural Resource: The country’s naturally endowed Nile River provides a prime technological architecture for power generation and a sustainable capacity of that resource offers attractive growth prospects and other contingencies for the entire project.

(d)       Risk: The project risk is comprised of two main components – the uncertainty about the pattern and amount of rainfall, and the volatility of the project’s operating cash flows.

(e)        Management: The real options that enhance the project’s passive net present value can only be identified and captured by an active equity participation of a skillful manager.

The research paper, “Valuation of a Hydro-Electric Power Project in Emerging Markets: An Application of Real Options,” is published in the current issue of the African Finance Journal.

For a copy of the paper, email wcaldwell@pace.edu .

About the Lubin School of Business at Pace University: Globally recognized and prestigiously accredited, the Lubin School of Business integrates New York City’s business world into the experienced-based education of its students at Pace’s suburban and downtown campuses, implemented by the region’s largest co-op program, team-based learning, and customized career guidance. Its programs are designed to launch success-oriented graduates toward upwardly mobile careers.  www.pace.edu/lubin

About Pace University: For 105 years Pace has educated thinking professionals by providing high quality education for the professions on a firm base of liberal learning amid the advantages of the New York metropolitan area. A private university, Pace has campuses in New York City and Westchester County, New York, enrolling nearly 13,000 students in bachelor’s, master’s, and doctoral programs in its Lubin School of Business, Dyson College of Arts and Sciences, College of Health Professions, School of Education, School of Law, and Seidenberg School of Computer Science and Information Systems. www.pace.edu

Media contact:  Bill Caldwell, Pace, 212-346-1597, wcaldwell@pace.edu

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