Valuation of Visaginas nuclear power plant project in Lithuania: Real option valuation using stochastic continuous-time modeling

Ieva Linkeviciute

Student thesis: Master thesis


This thesis values the Visaginas NPP project in Lithuania and provides with the optimal entry and exit strategy, which is found employing Dixit and Pindyck’s (1994) stochastic continuous-time real option valuation model extended with mean-reversion process. The model is used to answer such questions as: why and when is it/is it not worth to invest in a new nuclear power plant in Lithuania; and why and when is it/is it not worth to leave the market if the investment is already made. In addition, there is suggested the optimal capacity of a new nuclear power plant. The thesis provides with the description of the project, worldwide trends of nuclear power, the Lithuanian electricity market analysis, as well as the comparison of two investment valuation techniques – the traditional NPV analysis and the real option approach. Then the input variables for the continuous-time real option valuation model is calculated and used to find the optimal investment strategy using Wolfram Mathematica 7. Finally, the sensitivity analysis is followed by the suggestions about possible extensions of the thesis. The main findings of the thesis is, that the investment in the Visaginas NPP is economically sound and in line with Lithuania’s energy policy because nuclear energy can ensure stable and cost-effective base-load supply of electricity, it does not emit CO2, and together with renewable resources contributes to the sustainable development. The market conditions are also favourable, as the electricity demand is expected to grow significantly and there is expected a shortage of electricity corresponding to at least 10.5 TWh in 2020. The deregulation of electricity market and the establishment of Lithuanian power exchange have a positive effect on transparency and fair competition, while future integration with the common Nordic power market promises further development of the market. The optimal strategy to enter the market implies that the investment should be made when the electricity price reaches 0.11 LTL/kWh in Scenario I and 0.17 LTL/kWh in Scenario II. As the current price of electricity is around 0.16 LTL/kWh, the project would yield a payoff of 0.88 LTL per kWh of installed capacity in Scenario I and it would be optimal to wait and keep the option to invest alive in Scenario II. Once the investment is made, the nuclear power plant would operate at least 60 years. Even though electricity price may fall significantly, it is still optimal to stay in the market because the exit cost is high and the investors are expecting that electricity price will rise to its long-run mean level. Finally, the optimal capacity of the nuclear power plant is estimated at 1350 MW.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
Publication date2011
Number of pages83