Real options and cost-based access pricing: Model and methodology

This paper proposes a model and methodology for valuing the option to delay network investment decisions and calculating cost-based access prices. It argues that an option value multiple must be applied to the investment cost component of each network element in order to account for the value of the delay option that is extinguished at the time of investment. Option value multiples are calculated for the investment decision in three main network elements, each representing a different part of the Brazilian fixed telecommunications network, subject to different technological and demand uncertainties. After applying the markup factors, network costs must be assigned to network services on the basis of how much each service uses each network element.

► Real options (RO) model that can be easily applied on top of existing cost studies.
► An option value multiple is calculated for each main network element (NE).
► The option value multiple is negligible for some NEs and quite significant for others.
► The impact of RO on cost-based prices depends on how much each service uses each NE.
► The NE’s service demand is given by the NE’s cost driver volume.