Real Options in Capital Investment: Models, Strategies, and Applications

By Lenos Trigeorgis | Go to book overview

Chapter 15
Optimal Land Development

Laura Quigg

This paper presents a model that values land as a real option, incorporating the option to wait to develop the property. This option to wait has value in an uncertain economy because land is more than just a site for constructing a particular structure at a particular time. Effectively, a landowner holds an American-style option to develop the land at an optimally chosen time in the future. With much uncertainty, it may pay to hold the land vacant, even in the presence of thriving real estate markets. In addition to a valuation model, we develop rules for an optimal investment strategy and present useful comparative statics results.


15.1 INTRODUCTION

The value of a parcel of land can be determined as the net present value (NPV) of the stream of returns generated by the project that constitutes the highest and best use of the land. According to traditional capital budgeting, the investor determines the current worth of these rents based on the information available at the decision date. While it is possible to compare the value of an investment made today with one made tomorrow, or with a different-size project, the standard decision rule ignores the value of the option to delay the investment decision itself until a later date.

The model presented in this chapter values land as a real option, incorporating the option to wait to develop the property. This option to wait has value in an uncertain economy because land is more than just a site for constructing a particular structure at a particular time. A landowner holds an American-style option to build at an optimally chosen time in the future. The underlying asset for this option is one of several buildings, with exercise price equal to their respective construction costs. We here assume that there is a single underlying structure, although it is straightforward to extend the model to include the option to develop the most profitable

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Real Options in Capital Investment: Models, Strategies, and Applications
Table of contents

Table of contents

  • Title Page iii
  • Contents v
  • Tables and Figures ix
  • Preface xiii
  • Chapter 1 Real Options: An Overview 1
  • Introduction 1
  • Acknowledgments 28
  • Notes 28
  • Part I Real Options and Alternative Valuation Paradigms 29
  • Chapter 2 Methods for Evaluating Capital Investment Decisions Under Uncertainty 31
  • Introduction 31
  • Conclusion 44
  • Notes 45
  • Chapter 3 Merging Finance Theory and Decision Analysis 47
  • Introduction 47
  • Summary and Conclusion 65
  • Acknowledgments 66
  • Notes 66
  • Chapter 4 The Strategic Capital Budgeting Process: A Review of Theories and Practice 69
  • Introduction 69
  • Conclusions 84
  • Acknowledgments 86
  • Notes 86
  • Part II General Exchange or Switching Options and Options Interdependencies 87
  • Chapter 5 The Value of Flexibility: A General Model of Real Options 89
  • Introduction 89
  • Concluding Remarks 105
  • Acknowledgments 105
  • Notes 106
  • Chapter 6 The Valuation of American Exchange Options with Application to Real Options 109
  • Introduction 109
  • Conclusion 119
  • Acknowledgments 120
  • Notes 120
  • Chapter 7 Operating Flexibilities in Capital Budgeting: Substitutability and Complementarity in Real Options 121
  • Introduction 121
  • Conclusion 130
  • Acknowledgments 131
  • Notes 131
  • Part III Strategy, Infrastructure, and Foreign Investment Options 133
  • Chapter 8 The Value of Options in Strategic Acquisitions 135
  • Introduction 135
  • Implications and Conclusions 147
  • Acknowledgments 148
  • Notes 148
  • Chapter 9 Corporate Governance, Long-term Investment Orientation, and Real Options in Japan 151
  • Introduction 151
  • Implications and Conclusions 158
  • Notes 160
  • Chapter 10 Volatile Exchange Rates and the Multinational Firm: Entry, Exit, and Capacity Options 163
  • Introduction 163
  • Conclusions 178
  • Acknowledgments 180
  • Notes 180
  • Part IV Mean Reversion/ Alternative Formulations in Natural Resources, Shipping, and Start - Up Ventures 183
  • Chapter 11 The Effects of Reversion on Commodity Projects of Different Length 185
  • Introduction 185
  • Conclusions and Extensions 199
  • Appendix 201
  • Acknowledgments 204
  • Notes 204
  • Chapter 12 Contingent Claims Evaluation of Mean-Reverting Cash Flows in Shipping 207
  • Introduction 207
  • Conclusions 216
  • Appendix 217
  • Acknowledgments 218
  • Notes 218
  • Chapter 13 Valuing Start-Up Venture Growth Options 221
  • Introduction 221
  • Conclusion 236
  • Appendix 237
  • Acknowledgments 238
  • Notes 238
  • Part V Other Applications: Pollution Compliance, Land Development, Flexible Manufacturing, and Financial Default 241
  • Chapter 14 Investment in Pollution Compliance Options: The Case of Georgia Power 243
  • Introduction 243
  • Notes 262
  • Chapter 15 Optimal Land Development 265
  • Introduction 265
  • Conclusions and Extensions 277
  • Appendix 278
  • Acknowledgments 279
  • Notes 279
  • Chapter 16 Multiproduct Manufacturing with Stochastic Input Prices and Output Yield Uncertainty 281
  • Introduction 281
  • Conclusion 298
  • Appendix 300
  • Notes 301
  • Chapter 17 Default Risk in the Contingent Claims Model of Debt 303
  • Introduction 303
  • Conclusions and Extensions 317
  • Acknowledgments 318
  • Notes 319
  • Bibliography 323
  • Author Index 347
  • Subject Index 351
  • About the Editor and Contributors 357
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