Optimal Investment Strategies in Offshore Salmon Farming using Real Options Valuation Methods - A case study of SalMar ASA's investment in the Ocean Farming Facility
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The Norwegian salmon farming industry is struggling with growth due to governmental regulations imposed to solve biological and area challenges. In 2015, the Norwegian government introduced development concessions to fuel investments in innovative technologies solving these challenges and to ensure sustainable growth in the industry. SalMar ASA, a Norwegian salmon farming company, was the first company to receive development concessions through their investment in an offshore salmon farming facility. Investments in innovative technologies are often associated with a high level of uncertainty. According to Dixit and Pindyck (1994), real options analysis is more suitable than traditional financial frameworks under these circumstances. In this thesis, we extend real options literature by examining if real options analysis can improve SalMar s investment strategies. We present five different models to determine unit profit thresholds for optimal conversion of the development concessions. The models consider an American call option with a finite time horizon, and we use dynamic programming to develop both one-factor and multi-factor models. In the one-factor models the unit profit follows a geometric Brownian motion, while we in the multi-factor models describe the unit profit using two correlated geometric Brownian motions. We also investigate how seasonal variations in production and technological uncertainty affect the unit profit threshold. The technological uncertainty is accounted for by introducing the possibility of innovations arriving, which is described using a Poisson process. To solve the models, we develop algorithms based on explicit and implicit finite difference methods. Our results show that delaying conversion is optimal for a large range of unit profit levels. These results challenge the discounted cash flow analysis performed by SalMar, which found conversion to be optimal at first opportunity. Our research shows that real options analysis can provide salmon farming companies with valuable information and can be used as an additional tool with traditional financial frameworks. Additionally, our multi-factor models show that the unit profit threshold increases with higher unit production costs, showing the importance of modeling the profit using revenues and costs.