A commercial real estate company has an option to develop a parcel of land. Assuming the dynamics of land value, L, are described by geometric Brownian motion with drift a and volatility, and that the cost of developing the land is I, answer the following questions. Assume the economy is risk-neutral and the instantaneous risk-free rate of interest is r. a. Compute the value of the development option, F(L), and the optimal exercise policy, I, assuming the firm can exercise the option at any time. b. In a more realistic setting, the company may face competition that damages the value of its growth options. For simplicity, assume that the arrival of competition can be described as a Poisson process with intensity parameter 2; and that conditional on the arrival of competition, the development option becomes worthless (i.e., drops in value to zero). Compute the value of the option, F(L), and the optimal exercise policy, Î**, under this competition scenario. c. Compare the optimal exercise policies under parts a. and b. of this question. How does competition influence the optimal exercise policy?
A commercial real estate company has an option to develop a parcel of land. Assuming the dynamics of land value, L, are described by geometric Brownian motion with drift a and volatility, and that the cost of developing the land is I, answer the following questions. Assume the economy is risk-neutral and the instantaneous risk-free rate of interest is r. a. Compute the value of the development option, F(L), and the optimal exercise policy, I, assuming the firm can exercise the option at any time. b. In a more realistic setting, the company may face competition that damages the value of its growth options. For simplicity, assume that the arrival of competition can be described as a Poisson process with intensity parameter 2; and that conditional on the arrival of competition, the development option becomes worthless (i.e., drops in value to zero). Compute the value of the option, F(L), and the optimal exercise policy, Î**, under this competition scenario. c. Compare the optimal exercise policies under parts a. and b. of this question. How does competition influence the optimal exercise policy?
Managerial Accounting
15th Edition
ISBN:9781337912020
Author:Carl Warren, Ph.d. Cma William B. Tayler
Publisher:Carl Warren, Ph.d. Cma William B. Tayler
Chapter12: Capital Investment Analysis
Section: Chapter Questions
Problem 3DQ
Related questions
Concept explainers
Mortgages
A mortgage is a formal agreement in which a bank or other financial institution lends cash at interest in return for assuming the title to the debtor's property, on the condition that the obligation is paid in full.
Mortgage
The term "mortgage" is a type of loan that a borrower takes to maintain his house or any form of assets and he agrees to return the amount in a particular period of time to the lender usually in a series of regular equally monthly, quarterly, or half-yearly payments.
Question
Transcribed Image Text:A commercial real estate company has an option to develop a parcel of land. Assuming the
dynamics of land value, L, are described by geometric Brownian motion with drift a and
volatility o, and that the cost of developing the land is I, answer the following questions.
Assume the economy is risk-neutral and the instantaneous risk-free rate of interest is r.
a. Compute the value of the development option, F(L), and the optimal exercise policy, L,
assuming the firm can exercise the option at any time.
b. In a more realistic setting, the company may face competition that damages the value of its
growth options. For simplicity, assume that the arrival of competition can be described as
a Poisson process with intensity parameter 2; and that conditional on the arrival of
competition, the development option becomes worthless (i.e., drops in value to zero).
Compute the value of the option, F(L), and the optimal exercise policy, L, under this
competition scenario.
c. Compare the optimal exercise policies under parts a. and b. of this question. How does
competition influence the optimal exercise policy?
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
Step by step
Solved in 3 steps with 2 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
Managerial Accounting
Accounting
ISBN:
9781337912020
Author:
Carl Warren, Ph.d. Cma William B. Tayler
Publisher:
South-Western College Pub
Managerial Accounting
Accounting
ISBN:
9781337912020
Author:
Carl Warren, Ph.d. Cma William B. Tayler
Publisher:
South-Western College Pub