Question

Consider an investment in which a developer plans to begin construction, of a building that will cost $1,000,000, in one year if, at that point, rent levels make construction feasible. There is a 50 percent chance that NOI will be $160,000 and a 50 percent chance that NOI will be $80,000. Assuming a cap rate of 10 percent (12 percent discount rate and an NOI growth rate of 2 percent) what would the land value be at the completion of the construction, under the real options approach

Answer 1

Answer:

$300,000

Explanation:

Calculation to determine what would the land value be at the completion of the construction, under the real options approach

First step is to calculate the property worth

If NOI =$160,000

Capitalization rate = 10%

Property will worth =$160,000/10%

Property will worth =$1,600,000

Land value = $1,600,000 - $1,000,000 = $600,000

Second step is to calculate the property worth $

If NOI =$80,000

Capitalization rate = 10%

Property worth=$80,000/10%

Property worth =$800,000

Land value of $800,000 will be 0 reaosn been that the property cost is lower than the construction cost Base

Now let calculate the land value

Land value = 50%($600,000) + 50% ($0)

Land value = $300,000

Therefore what would the land value be at the completion of the construction, under the real options approach is $300,000