EQUILIBRIUM WITH TIME-TO-BUILD IN A COMPETITIVE INVESTMENT ENVIRONMENT - A REAL OPTIONS APPROACH TO INVESTMENT DECISION MAKING IN THE PULP AND PAPER INDUSTRY, 2008 Engineering, Pulping and Environmental Conference

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The financial objective of a corporation is to maximize shareholder value. Assuming that basic premise is nearly completely true, investment project analysis is synonymous with investment project valuation: investment in projects should be accepted if and only if their value exceeds their cost, so as to increase the wealth of shareholders. Investment in new plants or new products or new markets always happens under conditions of uncertainty. Most of the corporate investment decisions are made with the assumption that investment strategies can be formulated fairly well by accounting for the underlying risk (uncertainty) through Discounted Cash Flow – Net Present Value (DCF-NPV) analysis. Making use of two of the fundamental characteristics of many real-world investments - (i) investment takes time to build, and (ii) investment strategies take place in a competitive context and cannot be formulated in isolation - Real Options Method (ROM) provides a better approach to derive a dynamic competitive equilibrium for investment decisions in an industry like Pulp and Paper. However, such equilibriums are complicated by a potentially infinite state space, as future prices depend not only on completed supply, but also on the previous entry times of units in the supply pipeline. This paper synthesizes the equilibrium with time-to-build with competitive strategy in a real options valuation model as a realistic approach to making investment decisions in the Pulp and Paper Industry. Several interesting aspects of equilibrium are discussed and conclude that equilibrium asset values are path dependent, and equilibrium entry strategies are always conditional on a finite transformation of the original state space.