Evaluation of investment projects in the construction industry under extreme uncertainty
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ЗАЯВЛЕНИЕ О САМОСТОЯТЕЛЬНОМ ХАРАКТЕРЕ ВЫПОЛНЕНИЯ ВЫПУСКНОЙ КВАЛИФИКАЦИОННОЙ РАБОТЫ 2
STATEMENT ABOUT THE INDEPENDENT CHARACTER OF THE MASTER THESIS 2
Аннотация 3
ABSTRACT 4
Introduction 5
Chapter 1. Theoretical aspects of construction projects with extreme uncertainty 7
1.1 Basic concept of construction project 7
1.2 Methods for evaluation of construction projects 9
Chapter 2. Methodology and results of evaluation the construction project 15
2.1 Main method 15
2.1.1 Mathematical model of NPV 15
2.1.2 Modelling exposure time 16
2.1.3 Modelling average exposure time 18
2.1.4 Monte-Carlo Simulation 18
2.2 Description of project «NEO Sochi» 19
2.2.1 Project description 19
2.2.2 Input variables 21
2.3 Discount rate calculation 22
2.4 Evaluation of «NEO Sochi» 26
2.4.1 Regression model for average exposure time 26
2.4.2 Calculation of exposure time 27
2.4.3 Evaluation of expected NPV 28
2.4.4 Sensitivity analyses 31
2.5 Results and discussion 33
2.6 Practical recommendations 35
Conclusion 36
References 38
Appendix. Sensitivity analyses 40
STATEMENT ABOUT THE INDEPENDENT CHARACTER OF THE MASTER THESIS 2
Аннотация 3
ABSTRACT 4
Introduction 5
Chapter 1. Theoretical aspects of construction projects with extreme uncertainty 7
1.1 Basic concept of construction project 7
1.2 Methods for evaluation of construction projects 9
Chapter 2. Methodology and results of evaluation the construction project 15
2.1 Main method 15
2.1.1 Mathematical model of NPV 15
2.1.2 Modelling exposure time 16
2.1.3 Modelling average exposure time 18
2.1.4 Monte-Carlo Simulation 18
2.2 Description of project «NEO Sochi» 19
2.2.1 Project description 19
2.2.2 Input variables 21
2.3 Discount rate calculation 22
2.4 Evaluation of «NEO Sochi» 26
2.4.1 Regression model for average exposure time 26
2.4.2 Calculation of exposure time 27
2.4.3 Evaluation of expected NPV 28
2.4.4 Sensitivity analyses 31
2.5 Results and discussion 33
2.6 Practical recommendations 35
Conclusion 36
References 38
Appendix. Sensitivity analyses 40
The construction industry plays a vital role in determining the economic development of the modern world and meeting the essential needs of society. In the context of rapidly changing economic and technological requirements, this industry faces a number of complexities and challenges associated with uncertainty and high risks. In a construction project, uncertainty can occur due to incomplete knowledge of project parameters, changes in market conditions, problems in the construction process, and other factors. Construction development projects often faces with extreme uncertainty that relates to revenue obtained from selling developed real estate. Extreme uncertainty arises because we do not know whether real estate will be sold or not in particular period of time, so if it is sold, we have positive cash flow, if not - cash flow is zero. Such uncertainty can significantly affect the profitability of the project and cause risks for investors. Although various investment appraisal methods are used for construction projects, there is a lack of discussion in well-known literature regarding an approach that can account for the significant uncertainty associated with construction development projects. From a scientific point of view, the question has not been worked out, but this approach has high practical importance.
In my Master thesis method based on NPV techniques for the evaluation of construction project with high uncertainty will be introduced. In context of Thesis, uncertainty will be considered in exposure time (time to sale) of residential real estate. Introduced method will be implemented on real construction development project. This project is «NEO Sochi» that is elite cottage village of 6 cottages with an area of 215 m2 in the village «Chereshnya», Adler district, Sochi. Project is performed by LLC "Center for project management in housing and utilities", the aim of this project is to build and sell 6 cottages. Obtained results will be compared with traditional investment appraisal method NPV and discussed. Company finds it difficult to evaluate the effectiveness of this project due to extreme uncertainty, so traditional NPV approach is not suitable. Therefore, there is a practical need for method that succeed in evaluation of construction project with extreme uncertainty.
The research gap I would like to fill is the following. The evaluation of construction projects with a high degree of uncertainty is an area that has been little explored in the literature. Although there are studies on the assessment and management of risks in construction, most of them assume that uncertainties can be quantified and that probabilistic methods can adequately reflect their impact on project outcomes. However, in scenarios where uncertainty is particularly high, traditional risk management techniques may not provide accurate estimates of the potential impact on project success. Thus, there is a need for research that explores alternative methods for evaluating construction projects that can take into account the high level of uncertainty. This research gap highlights the need for further exploration of new approaches to project appraisal that can address the extreme uncertainty in construction projects.
Research goal of this paper is to evaluate construction project with extreme uncertainty «Neo Sochi» by introduced method.
In order to answer the research question, the following objectives was set:
1. Analyze methods of investment appraisal used in practice for the evaluation of construction projects with high uncertainty
2. Introduce methodology based on NPV
3. Collect data from construction proj ect with extreme uncertainty
4. Apply the proposed method for the construction project
5. Analyze the effectiveness of the investment project and provide practical recommendations
Method introduced has several managerial implications for investment projects in construction industry. First, it provides a more accurate and reliable method of evaluating the feasibility of investment projects under extreme uncertainty. Method provides valuable information that can aid managerial decision-making. One practical application of this method is that the company management can analyze the Net Present Values (NPVs) to make well-informed investment decisions and evaluate the probability of different project outcomes when faced with uncertainties. Second, it enables project managers to identify and manage risks more effectively, which can improve project outcomes. Third, the method yields information that can be utilized to determine the optimal selling price for individual cottages, thereby maximizing the NPV of the entire project, as well as identifying price thresholds.
Master thesis consists of Introduction, Chapter 1, Chapter 2, Conclusion, References and Appendix. Chapter 1 is devoted to literature review about theoretical aspects and methods of evaluation construction projects with extreme uncertainty. Chapter 2 is devoted to proposed methodology, description of chosen project, discount rate calculation, calculation of expected NPV, discussion of obtained results and practical recommendations. Conclusion summarizes the overall results of the Master Thesis. Reference part describes the list of literature used. Appendix is devoted to reference information for sensitivity analyses.
In my Master thesis method based on NPV techniques for the evaluation of construction project with high uncertainty will be introduced. In context of Thesis, uncertainty will be considered in exposure time (time to sale) of residential real estate. Introduced method will be implemented on real construction development project. This project is «NEO Sochi» that is elite cottage village of 6 cottages with an area of 215 m2 in the village «Chereshnya», Adler district, Sochi. Project is performed by LLC "Center for project management in housing and utilities", the aim of this project is to build and sell 6 cottages. Obtained results will be compared with traditional investment appraisal method NPV and discussed. Company finds it difficult to evaluate the effectiveness of this project due to extreme uncertainty, so traditional NPV approach is not suitable. Therefore, there is a practical need for method that succeed in evaluation of construction project with extreme uncertainty.
The research gap I would like to fill is the following. The evaluation of construction projects with a high degree of uncertainty is an area that has been little explored in the literature. Although there are studies on the assessment and management of risks in construction, most of them assume that uncertainties can be quantified and that probabilistic methods can adequately reflect their impact on project outcomes. However, in scenarios where uncertainty is particularly high, traditional risk management techniques may not provide accurate estimates of the potential impact on project success. Thus, there is a need for research that explores alternative methods for evaluating construction projects that can take into account the high level of uncertainty. This research gap highlights the need for further exploration of new approaches to project appraisal that can address the extreme uncertainty in construction projects.
Research goal of this paper is to evaluate construction project with extreme uncertainty «Neo Sochi» by introduced method.
In order to answer the research question, the following objectives was set:
1. Analyze methods of investment appraisal used in practice for the evaluation of construction projects with high uncertainty
2. Introduce methodology based on NPV
3. Collect data from construction proj ect with extreme uncertainty
4. Apply the proposed method for the construction project
5. Analyze the effectiveness of the investment project and provide practical recommendations
Method introduced has several managerial implications for investment projects in construction industry. First, it provides a more accurate and reliable method of evaluating the feasibility of investment projects under extreme uncertainty. Method provides valuable information that can aid managerial decision-making. One practical application of this method is that the company management can analyze the Net Present Values (NPVs) to make well-informed investment decisions and evaluate the probability of different project outcomes when faced with uncertainties. Second, it enables project managers to identify and manage risks more effectively, which can improve project outcomes. Third, the method yields information that can be utilized to determine the optimal selling price for individual cottages, thereby maximizing the NPV of the entire project, as well as identifying price thresholds.
Master thesis consists of Introduction, Chapter 1, Chapter 2, Conclusion, References and Appendix. Chapter 1 is devoted to literature review about theoretical aspects and methods of evaluation construction projects with extreme uncertainty. Chapter 2 is devoted to proposed methodology, description of chosen project, discount rate calculation, calculation of expected NPV, discussion of obtained results and practical recommendations. Conclusion summarizes the overall results of the Master Thesis. Reference part describes the list of literature used. Appendix is devoted to reference information for sensitivity analyses.
This work is devoted to evaluation of construction project «Neo Sochi» with extreme uncertainty. «Neo Sochi» - an elite cottage village of 6 cottages in the village «Chereshnya», Adler district, Sochi. Project is performed by LLC "Center for project management in housing and utilities", the aim of this project is build and sell 6 cottages. Extreme uncertainty comes from the fact that main project cash inflows are revenue obtained from selling residential real estate that depend on whether real estate will be sold or not in particular period of time. The complexity of such project lies in the fact that it contains many factors that can have a significant impact on the final result, but often cannot be predicted in advance. Traditional method NPV cannot be used for the evaluation of this construction project as it cannot truly account for extreme uncertainty. This is due to the fact that there is great uncertainty associated with changing market conditions and other factors that can significantly affect the amount of cash flows and project opportunities. This can lead to underestimation or overestimation of potential investments.
To evaluate project «NEO Sochi» special methodology was developed. Methodology based on one main source of uncertainty - exposure time. Prices and exposure time for similar cottages in the village «Chereshnya» were obtained as primary estimates from real estate agency at the request of the company. Based on this data exponential regression was built to quantify the relationship between prices and exposure time. Methodology assumes that prices are set by company realizing the investment project, and then based on given prices exposure time is modelled based on exponential regression model. After that, different exposure time is modelled based on random value. Then different Monte-Carlo simulations are calculated based on it, and final NPV is calculated as mathematical expectation. The Monte-Carlo method enables the assessment of a project even in situations of significant uncertainty, through the use of probability distributions to model project parameters. This results in both numerical and non-numerical metrics that can be relied upon for informed decision-making.
This methodology was successfully implemented, and goal of Master Thesis was achieved. The results of evaluation of project «NEO Sochi» are the following. Methodology indicates that on average NPV for the "Neo Sochi" construction project is 23.8 million RUB. The probability of achieving a positive NPV is high at 99.75%, and there is only a small chance of failure with a negative NPV of less than 1%. There is a greater than 50% chance of achieving NPV between 20 and 30 million RUB. NPV of over 35 million RUB is unlikely with a probability of less than 2%. Therefore, project «Neo Sochi» is worthwhile and with high probability will create value for investors and will be profitable. Expected NPV obtained by this method is slightly higher than figure obtained by traditional NPV. However, traditional approach provides a single number that is difficult to interpret without extra information and it doesn't account for uncertainty and can be difficult to interpret, while the presented methodology generates multiple NPV figures that incorporate uncertainty and are more accurate due to real market data. Moreover, NPV obtained through introduced methodology takes into account uncertainty in various exposure time scenarios, which makes it more accurate when compared to traditional NPV and provides range of NPV value with probabilities.
Results obtained in Master thesis have both practical and theoretical significance. As for theoretical significance, methodology developed in Master Thesis was described and implemented on real construction project with high uncertainty. According to literature review, methodology for construction projects with extreme uncertainty is not presented in well-known literature and not widely used in practice, so developed method has high theoretical significance and can be used for further research. As for practical significance, introduced method can be used for the evaluation of other construction development project, method accounted for extreme uncertainty and leads to more accurate results. Proposed method provides two important properties: first, the obtained information is useful for managerial decisions and can help analyze NPVs for investment decisions, reducing risks and assessing potential profitability. Second, the information can be used to determine optimal selling price for maximum NPV of the project and price thresholds, improving financial performance and efficiency. Moreover, based on this method, different practical recommendations can be developed.
Further research on the evaluation of construction projects with high uncertainty may focus on considering uncertainty in costs using Monte Carlo simulation method for calculating NPV. In the construction context, cost uncertainty can arise due to unforeseen problems, unexpected changes in plans, or other unexpected factors. The Monte Carlo simulation method allows to create models that can take into account such uncertainty. It will allow to conduct various experiments and analyze the results, which will determine the best course of action. In addition, more research can be done to address risks and uncertainties in other aspects of construction projects. For example, one might consider integrating risk and uncertainty into project schedules, cost estimates, and other cost-benefit measures.
To evaluate project «NEO Sochi» special methodology was developed. Methodology based on one main source of uncertainty - exposure time. Prices and exposure time for similar cottages in the village «Chereshnya» were obtained as primary estimates from real estate agency at the request of the company. Based on this data exponential regression was built to quantify the relationship between prices and exposure time. Methodology assumes that prices are set by company realizing the investment project, and then based on given prices exposure time is modelled based on exponential regression model. After that, different exposure time is modelled based on random value. Then different Monte-Carlo simulations are calculated based on it, and final NPV is calculated as mathematical expectation. The Monte-Carlo method enables the assessment of a project even in situations of significant uncertainty, through the use of probability distributions to model project parameters. This results in both numerical and non-numerical metrics that can be relied upon for informed decision-making.
This methodology was successfully implemented, and goal of Master Thesis was achieved. The results of evaluation of project «NEO Sochi» are the following. Methodology indicates that on average NPV for the "Neo Sochi" construction project is 23.8 million RUB. The probability of achieving a positive NPV is high at 99.75%, and there is only a small chance of failure with a negative NPV of less than 1%. There is a greater than 50% chance of achieving NPV between 20 and 30 million RUB. NPV of over 35 million RUB is unlikely with a probability of less than 2%. Therefore, project «Neo Sochi» is worthwhile and with high probability will create value for investors and will be profitable. Expected NPV obtained by this method is slightly higher than figure obtained by traditional NPV. However, traditional approach provides a single number that is difficult to interpret without extra information and it doesn't account for uncertainty and can be difficult to interpret, while the presented methodology generates multiple NPV figures that incorporate uncertainty and are more accurate due to real market data. Moreover, NPV obtained through introduced methodology takes into account uncertainty in various exposure time scenarios, which makes it more accurate when compared to traditional NPV and provides range of NPV value with probabilities.
Results obtained in Master thesis have both practical and theoretical significance. As for theoretical significance, methodology developed in Master Thesis was described and implemented on real construction project with high uncertainty. According to literature review, methodology for construction projects with extreme uncertainty is not presented in well-known literature and not widely used in practice, so developed method has high theoretical significance and can be used for further research. As for practical significance, introduced method can be used for the evaluation of other construction development project, method accounted for extreme uncertainty and leads to more accurate results. Proposed method provides two important properties: first, the obtained information is useful for managerial decisions and can help analyze NPVs for investment decisions, reducing risks and assessing potential profitability. Second, the information can be used to determine optimal selling price for maximum NPV of the project and price thresholds, improving financial performance and efficiency. Moreover, based on this method, different practical recommendations can be developed.
Further research on the evaluation of construction projects with high uncertainty may focus on considering uncertainty in costs using Monte Carlo simulation method for calculating NPV. In the construction context, cost uncertainty can arise due to unforeseen problems, unexpected changes in plans, or other unexpected factors. The Monte Carlo simulation method allows to create models that can take into account such uncertainty. It will allow to conduct various experiments and analyze the results, which will determine the best course of action. In addition, more research can be done to address risks and uncertainties in other aspects of construction projects. For example, one might consider integrating risk and uncertainty into project schedules, cost estimates, and other cost-benefit measures.
aspects of construction projects with extreme uncertainty, Introduction, Methods for evaluation of construction projects
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