Valuation of investment on a firm with trade credit under uncertainty: A real options approach

This paper intends to propose a corporate valuation framework by incorporating both the stochastic product price and the stochastic interest rate in a delay payment context. By using Ito-Isometry theorem, we derived the analytical solution for corporate value, based on which sensitivity analyses and further simulations for the real option value are performed. Some critical factors were considered in the sensitivity analysis of corporate value: the drift and the volatility in the price and in the interest rate processes, the price elasticity of demand, the cost rate, the market share, as well as the length of time period for delay payments. To valuate an opportunity of investment on a firm with trade credit under uncertainty, a real options model was employed. The simulation results for the real option value indicated that increasing demand elasticity, market share, number of time periods for delay payments, interest rate drift, price volatility, and interest rate volatility all contribute to increasing real option value, whereas the increasing cost rate and price drift lead to the decreasing real option value as expected.