| By: |
João Adelino Ribeiro (Faculdade de Economia, Universidade do Porto, Portugal);
Paulo Jorge Pereira (CEF.UP, Faculdade de Economia, Universidade do Porto, Portugal);
Elísio Brandão (Faculdade de Economia, Universidade do Porto, Portugal) |
| Abstract: |
This paper aims to establish a support decision model by which an optimal
mark-up (profit margin) in the context of a bidding process is reached through
the valuation of the option to sign the contract assuming the contractor is
chosen to perform the project. The price included in the bid proposal remains
unchanged from the moment the offer is sealed until the contractor has the
right - but not the obligation - to sign the contract, whereas construction
costs vary stochastically throughout the period. Contractors should only sign
the contract if the construction costs, at that moment, are lower than the
price previously defined. We evaluate the option using an adapted version of
the Margrabe (1978) exchange option formula and we also assign a probability
of winning the bid for each profit margin using a function that respects the
inverse relationship between these two variables. We conclude that to the
higher value of the option - weighted by the probability of winning the
contract - corresponds the optimal mark-up bid. Finally, we consider the
existence of penalty costs which makes the model more efficient in explaining
what actually takes place in some legal environments; we then conclude that
the option to sign the contract and, therefore, the optimal mark-up bid are
affected by their existence. |
| Keywords: |
Optimal bidding; real options; construction projects; price determination |
| JEL: |
G31 D81 |
| Date: |
2012–03 |
| URL: |
http://d.repec.org/n?u=RePEc:por:cetedp:1201&r=cfn |