Renewable energy sources are becoming more important as the world's supply of fossil fuels decrease and also due to environmental concerns. Since 2003, when the ethanolgasoline flex fuel car became commercially available in Brazil, the growth of this market has been significant, to the point where currently more than 50% of the fuel consumption of cars in Brazil is from renewable biofuels (ethanol). This has been made possible due to the success of the flex fuel car, which can run on ethanol, gasoline, or any mix of these in the same fuel tank, and which is sold at a premium over the non-flex models.Flex fuel cars, on the other hand, provide the owner with the flexibility to choose fuels at each refueling stop. Given the uncertainty on future prices of ethanol and gas, this option adds value to the owner since he can always opt for the cheaper fuel whenever he fills up his car. We use the Real Options method to analyze the value of the flex fuel option assuming both a Geometric Brownian Motion and Mean Reverting diffusion processes for the prices of gasoline and ethanol and compare the results arising from both methods. We conclude that the flex option value is significant using either method and twice as high as flex premium charged by the car manufacturers, which helps explain the success that this type of automobiles have gained in Brazil since 2003. Our results also indicate that consumers should be willing to purchase flex fuel cars even if manufacturers increase the flex premium.
On November 2005 the State Government of São Paulo, Brazil, announced the intention to bid a contract to provide passenger services for the Line 4 of the São Paulo Metropolitan Subway System. In this article we use the real options approach to analyze the effect of the government guarantees provided in the contract on the value and the risk of the project, as well as the cost and the risk of these guarantees to the government. The results indicate that the incentives proposed are effective in reducing the risk and increase the net value of the Project by 36% at a cost to the State of only 5% of the total value of the project. Additionally, we show that for a given cost to the government, the most effective risk reduction mechanisms are the ones that include a higher portion of demand guarantees in relation to the investment subsidy.
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