African Journal of Business Management Vol. 6(25), pp.7397-7402, 27 June, 2012 Available online at http://www.academicjournals.org/AJBM DOI: 10.5897/AJBM11.2794 ISSN 1993-8233 ©2012 Academic Journals Review A real options approach to ship investment appraisal Floriano C. M. Pires 1 , Luiz Felipe Assis 1 and Mauro Rezende Fiho 2 * 1 Ocean Engineering Department, Rio de Janeiro Federal University, Brazil. 2 Production Engineering Department, Gama Filho University, Brazil. Accepted 5 March, 2012 Initially, this paper presents a methodology for analysis of investment in a tanker ship, based on Monte Carlo simulation of auto-correlated series of time-charter rates and prices of new building and second hand ships. Subsequently, a real options analysis is introduced, considering the possibility of project abandonment. The method is employed for evaluation of the investment in a suezmax tanker. The results indicate that the investment analysis outcome is significantly sensitive to the consideration of the managerial flexibility to project abandonment. Finally, the paper discusses the effect of the decision maker’s risk attitude on the abandonment option value. Key words: Shipping investment appraisal, real options, risk attitude. INTRODUCTION The shipping sector is peculiar in terms of the investment rationale and investor behavior. The cyclical nature of the market, its extreme volatility and the international character of the operations are the main factors that confer unique characteristics to the sector. The rationale behind the investment decision varies according to the different shipping sectors, as well as the types of players. For example, decision criteria and available information vary between a container operator and a bulk carrier shipowner. An oil company willing to implement a logistical strategy and an asset player would also have different approaches to investment decision making. The nature of the ship investment problem has been studied by many authors, such as Klausner (1970), Haralambides (1993) and Thanopoulu (2002). Real options analysis (ROA) is nowadays largely applied for evaluating investment decisions under uncertainty. Particularly, in the shipping sector, ROA has been increasingly applied. Gonçalves (1993) has pioneered the application of real options approach in shipping economics. More recently, ROA has been recognized as a suitable methodology for shipping investment analysis. Bendall (2002) presents an overview on ROA applicability and a discussion on the relevant managerial *Corresponding author. E-mail: rezende_m@yahoo.com.br. options in response to future events in the uncertain environment of shipping markets. Some other authors have also dealt with ROA in ship investment decision making (Bendall and Stent, 2005; Dikos (2008). The present paper presents a methodology for ship investment analysis, considering the abandonment option. A typical tanker ship investment decision problem is analyzed on the basis of Monte Carlo simulation of the future behavior of time-charter and second hand prices. The contribution of this work is two-fold: it proposes a simple and practical approach and discusses the effect of the tanker investor’s risk aversion on the abandonment option value. This significant effect was not considered before in the literature. Initially, an alternative Monte Carlo approach to investment analysis in oil tankers is presented. Next, the method is adapted to incorporate the option to abandon. Finally, the article raises and discusses the issue of the impact of decision maker’s risk aversion on the option value. ANALYSIS OF INVESTMENT IN OIL TANKERS The present study considers the case of an oil company that runs both owned and chartered ships. The parcel of the demand for maritime transport that the oil companies engaged in the international market fulfill with owned