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Operational asset replacement strategy: A real options approach

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  • Zambujal-Oliveira, João
  • Duque, João
Abstract
This paper analyses the problem of replacement by investigating the optimal moment of investment replacement in a given tax environment with a given depreciation policy. An operation and maintenance cost minimization model, based on the definition of equivalent annual cost, is applied to a real options paradigm. The developed methodology allows for an innovative evaluation of the flexibility of replacement process analysis. A new two-factor evaluation function is introduced to quantify decisions on asset replacement under a unique cycle environment. This study improves upon previous findings in the literature as it accounts for autonomous salvage value processes. Based on partial differential equations, this model achieves a general analytical solution and particular numerical solution. The results differ significantly from those observed in one-factor models by showing evidence of over-evaluation in optimal levels of replacement, and by confirming suspicions that different types of uncertainties produce non-monotonous effects on the optimal replacement level. The scientific contribution of this study lies in new and stronger approaches to equivalent annual cost literature, supplying an algorithm for operation and maintenance cost minimization that is conditioned by autonomous salvage value. This study also contributes to the real options literature by developing a two-factor model with Brownian processes applied to asset replacement.

Suggested Citation

  • Zambujal-Oliveira, João & Duque, João, 2011. "Operational asset replacement strategy: A real options approach," European Journal of Operational Research, Elsevier, vol. 210(2), pages 318-325, April.
    • Handle: RePEc:eee:ejores:v:210:y:2011:i:2:p:318-325
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    References listed on IDEAS

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    Cited by:

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    2. Alejandro Mac Cawley & Maximiliano Cubillos & Rodrigo Pascual, 2020. "A real options approach for joint overhaul and replacement strategies with mean reverting prices," Annals of Operations Research, Springer, vol. 286(1), pages 303-324, March.
    3. Adkins, Roger & Paxson, Dean, 2017. "Replacement decisions with multiple stochastic values and depreciation," European Journal of Operational Research, Elsevier, vol. 257(1), pages 174-184.
    4. Yatsenko, Yuri & Hritonenko, Natali, 2017. "Machine replacement under evolving deterministic and stochastic costs," International Journal of Production Economics, Elsevier, vol. 193(C), pages 491-501.
    5. Wenbo Shi & Tianke Feng, 2016. "Examining supply contracts under cost and demand uncertainties from supplier’s perspective: a real options approach," International Journal of Production Research, Taylor & Francis Journals, vol. 54(1), pages 83-97, January.
    6. J. Riechi & V. Mácian & B. Tormos & C. Avila, 2017. "Optimal fleet replacement: A case study on a Spanish urban transport fleet," Journal of the Operational Research Society, Palgrave Macmillan;The OR Society, vol. 68(8), pages 886-894, August.
    7. Adkins, Roger & Paxson, Dean, 2013. "The effect of tax depreciation on the stochastic replacement policy," European Journal of Operational Research, Elsevier, vol. 229(1), pages 155-164.
    8. Alibeiki, Hedayat & Lotfaliei, Babak, 2022. "To expand and to abandon: Real options under asset variance risk premium," European Journal of Operational Research, Elsevier, vol. 300(2), pages 771-787.
    9. Gutiérrez, Óscar, 2020. "On the definition of the investment-uncertainty relationship," Journal of Economics and Business, Elsevier, vol. 112(C).
    10. Nunes, Cláudia & Oliveira, Carlos & Pimentel, Rita, 2021. "Quasi-analytical solution of an investment problem with decreasing investment cost due to technological innovations," Journal of Economic Dynamics and Control, Elsevier, vol. 130(C).
    11. Himpler, Sebastian & Madlener, Reinhard, 2011. "Repowering of Wind Turbines: Economics and Optimal Timing," FCN Working Papers 19/2011, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
    12. Qiang Li & Junwei Wang & Jian Ni & Lap Keung Chu & Congdong Li, 2019. "The optimal time to make a risky investment under a permanent exit option," Journal of Intelligent Manufacturing, Springer, vol. 30(7), pages 2669-2680, October.
    13. Trigeorgis, Lenos & Tsekrekos, Andrianos E., 2018. "Real Options in Operations Research: A Review," European Journal of Operational Research, Elsevier, vol. 270(1), pages 1-24.
    14. Zambujal-Oliveira, J., 2012. "Tax competition for foreign direct investment under information uncertainty," Economic Modelling, Elsevier, vol. 29(6), pages 2269-2273.

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