A Case Study on Pomace Olive Oil Investment-Option Valuation, Optimal Leverage and Expected Agency Costs

18 Pages Posted: 17 Sep 2010 Last revised: 29 Apr 2011

See all articles by Besbes Hachicha Sameh

Besbes Hachicha Sameh

University of Sfax - Faculty of Business and Economics

Fathi Abid

University of Sfax, Faculty of Economic and Management Sciences, Probability & Statistics Laboratory

Date Written: September 15, 2010

Abstract

Based on a case study firm whose asset is an investment option, this paper focuses on the debt financing impact and the existence of agency conflicts regarding the option exercise on optimal investment decisions, optimal capital structure and option value.

The investment opportunity which is a starting project consists on extracting and refining pomace olive oil. Two sequences are considered: a crude pomace oil extraction and pomace oil refining as a second sequence. The duration of each sequence is 20 semesters of which two semesters correspond to development phase and the commercialization spreads on 18 semesters from 1997 to 2006 for the initial sequence and 1998 to 2007 for the second sequence.

Conflicts of interest between equityholders-bondholders are managed through the optimal choice of the investment thresholds and optimal leverage. We show that debt financing may significantly distort investment decisions. Levered equityholders choose to speed up exercising the investment option when they maximize equity value instead of total firm value. This incentive reduces option value and optimal leverage and increases credit spread of risky debt. We find that expected agency costs constitute an important driver both of the optimal investment decisions and optimal capital structure. Numerical simulations illustrate how agency costs vary with the investment opportunity parameters.

Keywords: Extracting and refining pomace oil, investment option, optimal leverage, agency costs of overinvestment

Suggested Citation

Sameh, Besbes Hachicha and Abid, Fathi, A Case Study on Pomace Olive Oil Investment-Option Valuation, Optimal Leverage and Expected Agency Costs (September 15, 2010). Available at SSRN: https://ssrn.com/abstract=1677359 or http://dx.doi.org/10.2139/ssrn.1677359

Besbes Hachicha Sameh (Contact Author)

University of Sfax - Faculty of Business and Economics ( email )

Tunisia
97535280 (Phone)

Fathi Abid

University of Sfax, Faculty of Economic and Management Sciences, Probability & Statistics Laboratory ( email )

Road of Airport, Km 4
Sfax, sfax 3018
Tunisia
+216 7427 9154 (Phone)

Register to save articles to
your library

Register

Paper statistics

Downloads
31
Abstract Views
291
PlumX Metrics