Investment in Next Generation Networks and the Role of Regulation: A Real Option Approach



4.1.1 - General inputs

The risk-free rate is assumed to be constant and equal to 5.5% over the first phase of the
project. The risk-free rate corresponds roughly to the average cost of money in Europe over
the past twenty years.

The number of years after which main uncertainties disappear is assumed to be six years.
This is the average time lag between when the front-runner European telecommunication
operator adopts a new technology and when the last follower introduces it. The project time
optimality is evaluated every quarter.

4.1.1.1 - Citéfibre specific inputs

The actual fibre roll-out of Paris by Citéfibre began in the second half of 2005: this is the
date when the investment opportunity was irreversibly converted into a business plan. We
make use of the standard hypothesis of rational expectations: as a consequence, we assume
that the actual data on the relevant variables (volatility, annual payout and expected NPV)
from 2005 onwards correspond to the expectations formed by Citéfibre at the time when the
decision was made.

The market expectation of the NPV of cash flows associated with a single fibre
connection has been obtained by dividing the enterprise value (market capitalisation + debt)
at December 2005 by the expected number of homed passed at the same date24.

The annual payout per connection has been estimated by dividing the 2006 Citéfibre
revenues by the average number of the homes passed by the end of 2005 and those passed
by the end of 2006. We assume that a one-year investment postponement causes revenues
to be lost for the following three years, although by a decreasing amount: hence the initial
delay does not lead to a parallel shift over time in the flow of revenues but the gap is filled
in a 3-year time horizon. Three years were in fact the expected time by a new entrant such
as Citéfibre in order to reach its target penetration. Three years also reflect the average time
needed for a new entrant to catch up with the market share reached by operators which had

25



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