A2 - You have the possibility to purchase a piece of land that can be developed with an office building. The asking price for the land is 50 000 000 SEK. Assume that it takes no time to develop the property and that the property, if developed today, would have a market value of 280 000 000 SEK after development. The market value of properties developed for office use is expected to increase 1% per year in perpetuity and the volatility of the market value is 35% per year. The required rate of return on office buildings in this location is 6.5% per year. The risk-free rate of return is 3.5% per year. The development cost is 290 000 000 SEK and it is expected to stay at that amount in the foreseeable future. According to local building regulations, the land must be developed within three years. Otherwise the building permit expires and the land becomes worthless. Use the binomial option valuation method and risk-neutral valuation to determine whether or not it is profitable to purchase the land for 50 000 000 SEK. The length of each period in the binomial tree should be one year. otn Calculate the up and down movements of the underlying asset using the formulas e and -o tin i.e. use the formulas that you used in the option valuation project. e (10p) A2 - You have the possibility to purchase a piece of land that can be developed with an office building. The asking price for the land is 50 000 000 SEK. Assume that it takes no time to develop the property and that the property, if developed today, would have a market value of 280 000 000 SEK after development. The market value of properties developed for office use is expected to increase 1% per year in perpetuity and the volatility of the market value is 35% per year. The required rate of return on office buildings in this location is 6.5% per year. The risk-free rate of return is 3.5% per year. The development cost is 290 000 000 SEK and it is expected to stay at that amount in the foreseeable future. According to local building regulations, the land must be developed within three years. Otherwise the building permit expires and the land becomes worthless. Use the binomial option valuation method and risk-neutral valuation to determine whether or not it is profitable to purchase the land for 50 000 000 SEK. The length of each period in the binomial tree should be one year. otn Calculate the up and down movements of the underlying asset using the formulas e and -o tin i.e. use the formulas that you used in the option valuation project. e (10p)
