Valuation of a Power Plant with the Real Options Approach

Since the late 1990s, the Brazilian electric power industry has been undergoing significant structural changes, the main objective being to increase competition and attract private investment. Due to this, the National Electric Energy Agency has offered a large number of investment opportunities through auctions of the right to build and operate power plants (mostly hydroelectric) and transmission lines, including small hydroelectric plants.In this article we propose a valuation model for a power generation plant under uncertainty and with the flexibility to choose the optimal power purchase agreement using the real options approach, and then apply this model to the case of a small hydroelectric plant. The results indicate that the flexible project has a value significantly greater than that obtained through traditional discounted cash flow methods.