The Valuation of Localization Investments with Real Options: A Case from Turkish Automotive Industry

Abstract

Localization investments are made mainly to increase the domestic content of manufacturing, thereby to reduce the costs and import dependency. Since localization investments include technology transfer, they positively affect the developing economies. The arrival of the new technology to the country has a positive impact on development of the equipment, workforce and the final product. It is often applied in automotive industry. Through localization investments not only improvement of OEMs, but also development of involved subsidiary industry can be induced. As a developing economy itself, Turkey encourages these kinds of investments and gives governmental incentives. The problem here is the valuation of these investment projects accurately by including all strategic impacts. Just because localization projects involve many future growth opportunities, conventional valuation tools cannot value those embedded opportunities correctly and the value of the project mostly appears negative or very low. This situation can cause a misjudgment at the incentives stage. This paper analyzes the localization project, first with conventional NPV analysis, then with real options analysis and finally compares the results. As for the options analysis, the results of potential involvement of various option types such as sequential options approach are used in the valuation of a case from Turkish automotive industry.

Keywords

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