A Socioeconomic Valuation of an Irrigation System Project Based on Real Option Analysis Approach

Traditional net present value methods used to evaluate potential projects make no allowance for flexibility and assume a static environment. The concept of real options has extended into irrigation systems to model design flexibility in the realistically uncertain environment. In particular, this article extends the evaluation techniques of an irrigation dam by combining the real options approach along with the traditional on (Discount Cash Flow). However, whereas financial options are well-defined traded contracts, real options in irrigation systems are a priori undefined, complex and interdependent. Moreover, irrigation systems involve many more options than designers could consider. Therefore designers need to identify the real options most likely to offer good flexibility and the most value. This paper demonstrates the ease that irrigation systems economic analysis with risk analysis and real options can be valued by simulation software that is readily available to owners of personal computers. Sequentially, Discount Cash Flow analysis accompanied with real options approach facilitates decision making and encourages more sophisticated and realistic economic analysis of irrigation systems. Copyright Springer Science+Business Media B.V. 2009