Real Options Valuation of Highly Uncertain Investments: Are UMTS-Licenses Worth their Money?

Abstract

We adopt a real options approach to analyse the value of recently auctioned UMTS- licenses, focussing on Germany as the largest European market. For that purpose we develop a real options model with an abandonment as well as a growth option. Not having an appropriate underlying security of the options, we pursue an indirect approach by assuming a stochastic process for the number of mobile phone users. As we also take account of the optimal option exercise, we have to rely on numerical analysis rather than on closed form solutions. Our real options model enables us to value the flexibility inherent in the UMTS investments. On the basis of a sensitivity analysis it turns out that two variables are crucial for a positive expected value of the investments: the initial customer base of a mobile phone company as well as the realised net cash °ows per user.