Investment Analysis under Uncertainty: Real Options Valuation of Solar Photovoltaic Projects in South Korea

This paper presents an investment analysis of a land-based solar photovoltaic power generation project in a coastal region of South Korea by using real options theory (ROT) to address the limitations of traditional discounted cash flow (DCF) analysis under market uncertainty. Because volatility in the system marginal price (SMP) and renewable energy certificate (REC) prices can significantly affect the profitability of renewable energy investments, incorporating managerial flexibility through ROT is essential for reliable economic assessments. We estimate the critical investment price (CIP) using both a traditional DCF approach and a real options model, and further examine how a government’s long-term fixed price contract influences investment outcomes. The CIP by ROT is derived within a Hamilton-Jacobi-Bellman (HJB) framework. Results indicate that the CIP obtained from ROT is generally higher than that from DCF, reflecting option value from managerial flexibility; moreover, this difference increases as price volatility increases. We also find that long-term fixed-price contracts can reduce revenue uncertainty, thereby lowering required rate of return, the investor’s equity share, and the CIP, ultimately improving project attractiveness to investors. Under the long-term fixed-price contract, the project achieves an internal rate of return (IRR) of 5.75%, exceeding the weighted average cost of capital (WACC) of 3.58%, suggesting that the project is economically feasible.