A real options approach to evaluating investments in the South African chemical industry.

Abstract

Investment in the South African economy is acutely needed for it to absorb the high numbers of unemployed and to grow the economy. The valuation of potential investments needs to capture all sources of revenue so that the investor has all possible information about the enterprise. The current methods of evaluating capital investment in the South African Chemical Industry continue to be based almost exclusively on Discounted Cash Flow (DCF) methods. While these techniques are certainly useful, they are unable to capture all aspects of capital investment viability. A more recent valuation technique of regarding investments as options can substantially change the decision making process about capital investment. Investment in the chemical industry can be viewed as a strategic initiative to develop the long term potential of the industry. This investment can also contribute to growth in other sectors of the economy. While these benefits are difficult to measure, the criteria of maximizing investor returns remain the cornerstone of any investment decision. Using the DCF methods and real options framework for analyzing capital investments, a proposed investment to manufacture the chemical resorcinol in South Africa will be analysed. This study will illustrate how the real options approach, developed in this study, can more fully capture the dynamic and strategic value of the investment project, than the DCF methods.