Question

J&R Construction Company is an international conglomerate with a real estate division that owns the right to erect an office building on a parcel of land in downtown Sacramento over the next year. This building would cost $44 million to construct. Due to low demand for office space in the downtown area, such a building is worth approximately $42 million today. If demand increases, the building would be worth $46.5 million a year from today. If demand decreases, the same office building would be worth only $40 million in a year. The company can borrow and lend at the risk-free annual effective rate of 47 percent. A local competitor in the real estate business has recently offered $846,000 for the right to build an office building on the land. What is the value of the office building today? Use the two-state model to value the real option. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.) Building value

Answer 1

A en Giver dal-a The buisin $44mon demand orease ,he bulado sould be f deand decreasethe Same office buisding could be woth a yea iss free aaval effeckive he ate is y,*7 PYCcoOl neal eale has necemy offesied 46,000 0oe yea u68miuion 0.846 mfoon 42 mion P Me csost, of the buflding sha the demamd SOCYeases eoud be. 47.346 oion. denamd decseoses the coot of the buidolin Lu-'p' be Hhe probabílípy of focx€Ose io the demand an herefone He. decyeae fo the demand could Jbe'/-p'.

giver giss ree A L 42 047 x 1.04 = 47 346p 4o846 - 40.846P 43.914 P O.48 -po.Sa Ezpeced cash floc 0.48 x 7.346 0.SQx 40846 y (1/,0u) Prejeml value today 1s Tenefoone he vaue of office bufdding 41.99 moos