Future-proofing—Valuing Adaptability, Flexibility, Convertibility and Options: A Cross-Disciplinary Approach

180 Pages·2020·4.354 MB·English

by  David G. Carmichael

Management in the Built Environment
Series Editor: Low Sui Pheng
David G. Carmichael
Future-proofing—
Valuing Adaptability,
Flexibility,
Convertibility
and Options
A Cross-Disciplinary Approach
Management in the Built Environment
Series Editor
Low Sui Pheng, National University of Singapore, Singapore, Singapore
Editorial Board
Abdul Rashid Bin Abdul Aziz, University Science Malaysia, Penang, Malaysia
An Min, Salford University, Salford, UK
Azlan Shah Ali, Faculty of Built Environment, University of Malaya, Department
of Building Surveying, Kuala Lumpur, Malaysia
Faisal M. Arain, Niagara College, Makkah Campus, Welland, ON, Canada
Fang Dongping, Tsinghua University, Beijing, China
Gao Shang, University of Melbourne, Parkville, VIC, Australia
George Ofori, London South Bank University, London, UK
Hamzah A. Rahman, University of Malaya, Kuala Lumpur, Malaysia
Javier Cuervo, Department of Management and Marketing, University of Macau,
Taipa, Macau, Guangdong, China
LiuJunying,DepartmentofConstructionManagement,TianjinUniversity,Nankai,
Tianjin, China
Oluwayomi K. Babatunde, Construction Economics & Management, University
of the Witwatersrand, Johannesburg, Gauteng, South Africa
Oswald Chong, School of Sustainable Engineering and the Built Environment,
Arizona State University, Tempe, AZ, USA
The aim of this book series is to provide a platform to build and consolidate a
rigorous and significant repository of academic, practice and research publications
that contribute to further knowledge relating to management in the built
environment. Its objectives are to:
1. Disseminatenewandcontemporaryknowledgerelatingtoresearchandpractice
in the built environment
2. Promote synergy across different research and practice domains in the built
environment and
3. Advance cutting-edge research and best practice in the built environment
The scope of this book series is not limited to “management” issues per se
because this then begs the question of what exactly are we managing in the built
environment.Whiletheprimaryfocusisonmanagementissuesinthebuildingand
construction industry, its scope has been extended upstream to the design
management phase and downstream to the post-occupancy facilities management
phase. Management in the built environment also involves other closely allied
disciplines in the areas of economics, environment, legal and technology. Hence,
the starting point of this book series lies with project management, extends into
construction and ends with facilities management. In between this spectrum, there
arealsoothermanagement-relatedissuesthatarealliedwithorrelevanttothebuilt
environment. These can include, for example cost management, disaster manage-
ment, contract management and management of technology.
This book series serves to engage and encourage the generation of new
knowledge in these areas and to offer a publishing platform within which different
strands of management in the built environment can be positioned to promote
synergistic collaboration at their interfaces. This book series also provides a
platform for other authorstobenchmarktheirthoughtstoidentify innovativeideas
that they can further build on to further advance cutting-edge research and best
practice in the built environment.
Ifyouareinterestedinsubmittingaproposalforthisseries,pleasekindlycontact
the Series Editor or the Publishing Editor at Springer:
Low Sui Pheng ([email protected]) or
Ramesh Premnath ([email protected])
More information about this series at http://www.springer.com/series/15765
David G. Carmichael
fi —
Future-proo ng Valuing
Adaptability, Flexibility,
Convertibility and Options
A Cross-Disciplinary Approach
123
DavidG.Carmichael
Schoolof Civil andEnvironmental Engineering
UNSW Australia
Sydney,NSW,Australia
ISSN 2522-0047 ISSN 2522-0055 (electronic)
Managementin the BuiltEnvironment
ISBN978-981-15-0722-9 ISBN978-981-15-0723-6 (eBook)
https://doi.org/10.1007/978-981-15-0723-6
©SpringerNatureSingaporePteLtd.2020
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To Maria
Preface
This book is about anticipating possible futures and embracing thinking about
adaptability, flexibility, convertibility and options. Possible futures contain uncer-
tainty (implying probability, likelihood or frequency of occurrence, in contrast to
determinism—Carmichael, 2014). Flexibility, adaptability and convertibility here
refer to a capability to make changes in line with future circumstances. Making
changes, among other things, can delay obsolescence—physical, economic, func-
tional, technological, environmental, social or legal.
The book’s presentation of a unified approach, across multiple situations and
multipledisciplines,tovaluingadaptability,flexibility,convertibilityandoptionsis
original to the author. The book, being multidisciplinary, will be of interest to
anyone involved in future-proofing, assets, investment and management.
Adaptability, flexibility and convertibility thinking fit generally within the field
of options—provisions are made now that set up options to make changes or take
someactioninthefuture,butexercisingtheseoptionsisdiscretionarydependingon
how the future unfolds. In valuing such options, the book’s approach has many
strengths over existing practices.
The approach given in this book avoids all the criticisms present in the use of
traditional financial option analogies to non-market-based situations. It offers a
ready way to value multiple situations, requires minimal financial knowledge and
mathematical sophistication, and hence can be readily implemented by practition-
ers. Numerical studies, to date, demonstrate that the book’s approach gives
acceptable estimates in valuing options. Coupled with a second-order moment
analysis, the combined approach offers advantages over other methods: the calcu-
lations align with common investment and viability calculations; it is intuitively
appealing and intuitive to understand; the calculations are straightforwardly per-
formed,forexample,onaspreadsheet;noassumptionsaremadeontheprobability
distributions of the underlying cash flows; it does not rely on the financial market
options literature including forced analogies; the concept of volatility is avoided,
while acknowledging that uncertainty can exist beyond the option exercise date;
therearenodeterministicrestrictionsonanyexerciseprice;multipleexercisedates
are possible; interest rates containing uncertainty and multiple interest rates can be
vii
viii Preface
used; variances can differ between variables and over time; discrete or continuous
timediscountingispossible;andanycombinationofcashflows,includingnegative
cash flows, is possible.
Financialoptionsterminologyisdeliberatelyavoidedasmuchaspossibleinthis
book in order to show the stand-alone nature of the book’s approach. However,
financialoptionsarementionedoccasionally,inordertolocatethisbookwithinthe
existing literature.
Sydney, Australia David G. Carmichael
Contents
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.1 Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.2 Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
1.3 Book Outline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.4 Future Directions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
1.5 Appendix: The Carmichael Equation—Derivation. . . . . . . . . . . 8
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
2 A Common and General Formulation. . . . . . . . . . . . . . . . . . . . . . . 13
2.1 Notation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
2.2 Outline. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
2.3 Summary Option Calculation Steps . . . . . . . . . . . . . . . . . . . . . 16
2.4 Second Order Moment Analysis . . . . . . . . . . . . . . . . . . . . . . . 16
2.5 Estimating Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
2.5.1 Moments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
2.5.2 Correlations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
2.6 Estimating Disbenefits and Benefits . . . . . . . . . . . . . . . . . . . . . 18
2.6.1 General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
2.6.2 Social and Environmental Estimates . . . . . . . . . . . . . . 19
2.7 Discounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
2.8 Distribution for Present Worth. . . . . . . . . . . . . . . . . . . . . . . . . 21
2.9 Calculating U and M . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
2.10 Comparison with Financial Market Options Techniques . . . . . . 22
2.11 Appendices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
2.11.1 Appendix: Deterministic Expressions. . . . . . . . . . . . . . 24
2.11.2 Appendix: Probabilistic Cash Flows . . . . . . . . . . . . . . 25
2.11.3 Appendix: Probabilistic Cash Flows and Interest
Rates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
2.11.4 Appendix: Variance and Volatility. . . . . . . . . . . . . . . . 28
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
ix
x Contents
3 Real Options. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
3.2 Real Option Types . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
3.3 Option to Expand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
3.4 Option to Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
3.5 Option to Abandon. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
3.6 Choice in Option Types . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
3.7 Switch in Practices, Change in Form . . . . . . . . . . . . . . . . . . . . 40
3.8 Delay, Deferment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
3.9 Sequential Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
3.10 Parallel Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
3.11 Rainbow Option . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
3.12 Closure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
3.13 Extensions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
4 Adaptable Infrastructure—Civil . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
4.2 Examples of Possible Built-in Adaptability/Flexibility. . . . . . . . 54
4.3 Flexibility Comparative Analysis . . . . . . . . . . . . . . . . . . . . . . . 54
4.4 Summary of Method. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
4.5 Case Example. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
4.6 Closure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
4.7 Extensions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
5 Adaptable Buildings and Houses. . . . . . . . . . . . . . . . . . . . . . . . . . . 61
5.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
5.2 Examples of Possible Built-in Adaptability/Flexibility. . . . . . . . 62
5.2.1 General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
5.2.2 Houses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
5.2.3 Buildings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
5.2.4 The Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
5.2.5 Costing Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . 65
5.3 Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
5.3.1 Typical Alteration—NA Form. . . . . . . . . . . . . . . . . . . 65
5.3.2 Flexibility: Built-in (A) Form . . . . . . . . . . . . . . . . . . . 66
5.4 Comparative Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
5.4.1 Outline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
5.4.2 Financial Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
5.4.3 Environmental Analysis . . . . . . . . . . . . . . . . . . . . . . . 68
5.4.4 Social Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69