A Compound Exchange Options Model to Valuate a Smart City Investment in Photovoltaic Plants

Solar energy projects represent a sustainable investment opportunity. This sustainability aspect becomes stronger if the solar energy projects involve more inhabitants by pursuing at the same time the smart city goal. The valuation of these projects is a very demanding task since they are characterized by unpredictable price of electricity and uncertainty about their future performance. In addition to this, the smart city projects are characterized by sequential logic because they are not pursued in oneshot investment but they are characterized by various investment stages. Considering these peculiarities, the classical discounted cash flows methods, such as the Net Present Value (NPV), are inadequate to valuate this project since they are not able to capture riskiness aspects and sequential logic. This paper proposes an innovative methodology to make an ex-ante valuation of a solar plant project in order to make conscious the potential investor about the actual profitability of this smart city investment. We apply the compound exchange options approach in order to consider the stochastic nature of revenues and costs, the sequential logic and the “optionality” to abandon the project if it becomes unprofitable during the time. The latter aspect allows to mitigate the project riskiness. A case study is also proposed and results show that, differently from NPV, the compound exchange options model prices adequately the smart city projects in renewable field that, in addition to be financially profitable, are in line with UN Sustainable Development Goals.