Valuation models for wind farms under development: A real options perspective

Søren Gantov Frølunde & Peter Elsborg Obling

Student thesis: Master thesis


This thesis has two objectives. The first objective is to investigate the possibility of developing a real options valuation model to improve the valuation of a wind farm under development compared to discounted cash flow valuation models. The second objective is to compare the usability of these models. In order to reach the two objectives we use a case study approach with a valuation of a Danish wind farm under development. Before the valuation a thorough comparative analysis of the different valuation models is undertaken to create a deeper understanding of the reasoning behind them. The thesis thus has both a theoretical and practical scope; but with an emphasis on the practical, as the discussion of theory revolves around solving practical issues. After the introduction, the second chapter presents the case, which includes a discussion of the process of developing wind farms in Denmark, the electricity market and the electricity price. The chapter thereby provides some fundamental insights about wind farm development and its main value drivers. We end this chapter with the observation that real options valuation seems suitable for investments in wind farms under development. The next chapter in the thesis is the theoretical discussion where the different valuation models are evaluated on four criteria that are particularly relevant for a valuation model of wind farms under development. In the discussion, it becomes clear that the assumptions of all financial models are strong, and that real options valuation models should not be discarded due to this factor. Instead the models’ ability to improve decision making in a company should be the focus and here the real options valuation model has much to offer. Based on this potential, as well as the real options valuation model’s superiority in handling uncertainty and flexibility, we find that it is a better model for valuing wind farms under development than the DCF based alternatives. In the two practical valuation chapters we develop our six step real options valuation model for wind farms under development, by gradually increasing the amount of factors taken into consideration. The model demonstrates the possibility of actually implementing real options valuations in a meaningful way by practitioners, such as the case company European Energy. The valuation does however underline the novelty of the field by highlighting the complications of estimating volatility and including the value of the interest tax shield. The conclusion of the thesis is that while we can develop theoretically advanced valuation models, their practical value and usability can be debated based on the difficulties of finding reliable estimates.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
Publication date2010
Number of pages152