An Approximation to Real Options Analysis (ROA) in a Colombian Construction Company: The Case of HL Ingenieros

An Approximation to Real Options Analysis (ROA) in a Colombian Construction Company: The Case of HL Ingenieros

Mauricio Guerrero-Cabarcas (Universidad EAN, Colombia), William Zuluaga-Muñoz (Universidad EAN, Colombia), Andrés Aguilera-Castillo (Universidad EAN, Colombia), Sandra Ximena Díaz-Sánchez (Universidad EAN, Colombia) and Carlos Hernán Fajardo-Toro (Universidad EAN, Colombia)
DOI: 10.4018/978-1-5225-5784-5.ch001

Abstract

This chapter aims to apply a real options analysis to a Colombian mid-size construction company HL Ingenieros presented as a case study looking to expand the variables considered in business valuations so companies can access new sources of funding, improve their capital structure, and become an investment opportunity for inbound foreign direct investment to the country. Most companies are not able to attract these funds due to (1) lack of development in the Colombian capital markets, (2) the lack of information that makes valuation difficult, and (3) the lack of use of alternative methods of valuation that include available strategic options. Several scholars have discussed the use of real options as an alternative method for business valuation that includes the effect of operational flexibility. This case study explores the potential gains in the use of real options for business valuation in companies from emerging countries planning to internationalize their operations.
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Case Background

The lack knowledge of financial tools is the common denominator that explains the low productivity of companies in the construction sector in Colombia. Osorio (2006) mentioned that there is no industrialization of the construction process, that construction activity is not independent of the economic cycle, nor have the organizations developed internal capacities that allow better financial management of projects to access diverse funding sources through capital markets.

Entrepreneurs have the perception that the most important problem in Latin America for the development of internal capacities is lack of financing. However, Amaya (2005) points out that the main drawback lies in the lack of development of human resources in financial matters, with staff required merely to optimize cash management. It is true that SMEs in construction suffer from liquidity constraints, which lead them to seek alternative sources of credit. Nonetheless, financial institutions are aware that providing credit to companies whose staff is not trained to manage these funds may result in a counterproductive and risky situation (Rostamkalaei & Freel, 2016).

Additionally, some research has pointed to the relative volatility in SME results compared to larger companies because of the marked differences in cash positions and profits generated from one period to the next, which is explained by their lower liquidity (Moldovan, Vătavu, Albu, Panait & Stanciu-Mandruleanu, 2016; Forte, Barros & Nakamura, 2013; Filipe, Grammatikos, & Michala, 2016; Azeez, Abubakar & Olamide, 2016). Essential is financial management, especially in the construction sector, as a result of the close relationship between working capital and overtrading, due to the lack of medium- and long-term financing available to firms in the sector and the consequent reliance on short-term financing (McGuinness & Hogan, 2016; Baños, García & Martínez, 2016).

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