IRREVERSIBLE INVESTMENT UNDER UNCERTAINTY

Abstract

Many organizations that received licenses to construct petroleum refineries in Nigeria failed to utilize their licenses despite the fact that Nigeria imports petroleum products. It is not clear why investors who obtained license to construct refineries did not utilize their licenses. The goal of this thesis is to develop mathematical models for irreversible investment decision making involving uncertainty and use the models to analyze irreversible investment decision rules. In order to account for plant capacity utilization in the derivation of irreversible decision rules, this thesis modifies the geometric Brownian motion and the arithmetic Brownian motion for the value of the project. Using stochastic calculus, the critical value V ∗ for the project, at which it is optimal to invest is derived for two investment decision rules. Using available data on regional refining margins and reports for refinery utilization, the ideal case is compared to what is experienced in practice. The Mathematical results show that plant capacity utilization has an inverse relationship with the investment trigger, and hence irreversible investment decisions are linked to plant capacity utilization. The analytical results show that when plant capacity utilization is low, the profit margin will also be low, which is different from the profit margin when the plant capacity utilization is high. It is recommended that stakeholders should find ways of improving plant capacity utilization in existing refineries so as to attract investors.