Optimal Seismic Upgrade Timing in Seaports with Increasing Throughput Demand via Real Options

Abstract

A real options (RO) formulation is proposed for decision-making on the timing to upgrade the seismic performance of existing seaports with increasing throughput demand in earthquake prone areas. The pay-off of the seismic upgrade investment option is estimated based on projected net earnings, repair cost, and downtime for a damaging reference seismic event having a pre-specified annual probability of occurrence. These projections inform a discrete-time RO binomial tree, following the American option valuation framework, which propagates the probability of the reference seismic event assuming Poisson temporal distribution of earthquake occurrence. The net present value of the expected annual payoff of the considered investment is used as an index supporting risk-informed decision-making discounted by the weighted average cost of capital (WACC). Numerical examples pertaining to decision makers with different capital cost, namely port authorities and terminal operators, operating in different economic environments typical of developed and developing countries are furnished to illustrate the applicability of the proposed RO formulation. It is found that high WACC and/or low throughput growth bring the optimal seismic upgrade timing forward, while earthquake consequences and upgrade cost have almost no influence on this timing.

Optimal Timing of the Seismic Vulnerability Reduction Measures Using Real Options Analysis

“…For instance, Ford et al (2002) described several advantages of using real options in construction projects by providing managers with 1) a better understanding of project uncertainties, 2) more flexibility through evaluation of projects scenarios, 3) enhanced strategies and comprehensive managerial decisions, and 4) competitiveness to catch latent values in projects. Savvidis et al (2019) evaluated the application of RO to the timing of investment in the seismic upgrade of seaports considering the growth of the demand over time.…”