Optimal firm entry and exit in the ethanol industry
Ornelas Gonzalez, Myrna A.
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The objective of this thesis is to evaluate entry and exit investment decisions for an ethanol plant in the state of Georgia under a real options approach (ROA) and compare the results to those obtained under the traditional net present value (NPV) approach. Dixit and Pindyck’s model of a firm’s entry and exit decisions under irreversible investment and price uncertainty is used to model entry and exit ethanol margin thresholds. We evaluate entry/exit decisions for two different size conventional ethanol plants: a 50 million gallon/year and a 100 million gallon/year plan under both the ROA and NPV approaches. Results suggest that by considering the stochastic nature of the ethanol margin, the irreversibility of investment in an ethanol plant, and the possibility to delay the investment /disinvestment decisions, the ROA yields more ―cautious‖ thresholds- the gap between entry and exit margins is shown to be consistently larger with ROA.