A Real Options Approach to Hybrid Electric Vehicle Architecture Design for Flexibility

Manufacturers launch new product models at various time increments to meet changing market requirements over time. At each design period, product design and price may change. While price decisions can be made at product launching time, redesign decisions must be made in advance. Real options theory addresses such time gap decisions. This paper presents a real options approach with a binomial lattice model to determine optimal design and price decisions for hybrid electric vehicles (HEVs) that maximize expanded net present value of profit under gas price uncertainty over time. Results confirm that we can obtain changing vehicle attributes by changing gear ratios rather than the architectures themselves due to high cost of redesigning. A parametric study examines the impact of gas price volatility on option decisions and shows that larger volatility of gas price causes the change option to be selected more frequently. NOMENCLATURE X Design at time t P (t) Price of a new design at time t P ′(t) Price of the current design at time t V (t) Profit at time t PV (t) Present value of profit at time t I Initial investment NPV (0) Net present value of whole design project ni i-th node at time t ∗Address all correspondence to this author. p Probability of gas price being increasing u Proportional increase in gas price d Proportional decrease in gas price σ Volatility of gas price G Initial gas price r Risk-free interest rate C Redesign cost ρ Planetary gear ratio FR Final drive ratio