REIT Co.1 You are a BBA graduate, class of 2001 and thereafter immediately began working for REIT Co. (A REIT is a Real Estate Investment Trust, whereby the focus is to invest in real estate assets). As it is 2001, the real estate bubble (and collapse) havnt happened and the market is beginning to take off. One Monday morning in February 2002 you are helping your Associate and VP on a deal. You suddenly feared that your company, REIT Co., may have lost several million as a consequence of an unexpected adverse event. REIT Co. REIT Co. started in December 2000: the Principal raised 15 million from a group of UK investors and founded REIT Co. with a focused strategy to acquire properties with recreational potential. REIT Co. often consolidated several parcels and obtained leases from the European Union Environment Agency to create a desirable recreational property. Once the lease had been obtained, REIT Co. would either sell it to another developer or actually make initial improvements themselves (via contractors) before selling to enhance the property value. REIT Co. had a policy against operating any resorts and would only hire a third party contractor to undertake 1 to 2 years of initial development, including roads, sewers, and the core facilities (a few condominiums, tennis courts, a golf course, ski runs, etc.). Initial development was aimed at demonstrating the potential rather than completely exploiting it. 1 This case was prepared based on a real life client setting. However, all names of individuals and companies, numbers are fictitious. Jafskil Ski Development The problem facing your team involved a set of land parcels in the White Mountain range, located approximately 100 kilometres from a large metropolitan area and near two welldeveloped ski areas. The elevation varied from 2,000 to 3,000 metres, and snowfall from December to March was usually between 6 and 10 metres. Summer recreation was also possible since the property was split by a river and had good access (15 minutes) to a lake large enough for water skiing and sailing. In June 2001, your team was looking at three parcels that would allow REIT Co. to create a ski resort tentatively named the Jafskil Ski area. The parcels have access to the east side of White Mountain, which was managed by the EU Environment Agency. REIT Co. controlled these three parcels through a package of options that they had bought in June 2001 at a price of 500,000. The options gave REIT Co. the right, but not the obligation, to acquire the three parcels in June 2002 at a price of 10 million (in financial terms, the 500,000 is known as the option price, the 10 million is the strike price, and June 2002 is the maturity date). In order to be able to develop the parcels into a ski resort, REIT Co. needed permission from the EU Environment Agency. In fact, the Agency had not yet agreed to lease the east side of the mountain for development as a ski area. However, when REIT Co. had purchased the options in June 2001, the team had been sure that a lease from the EU Environment Agency would be obtained before December 2001 because they already had agreed in principle. Unfortunately, in November 2001, five months after the options were purchased, a group of conservationists had filed a lawsuit to stop construction of a ski resort 50 kilometres north of White Mountain. Their injunction was obtained by demonstrating that the environmental impact report, used as a basis for the construction permit, was inadequate. Since the EU Environment Agency had been involved in the preparation of the report, and the agency was also leasing part of the land to be used in the development, the injunction was directed at the EU Environment Agency as well as the developers. Because of the suit, the EU Environment Agency Commissioner refused to consider any new lease permits until the outcome of the suit was known. The Principal at REIT Co. believed that the situation was out of his control. He had already pursued all the political lines available to him and the answer was consistent: Youll just have to wait until the suit is settled. There is nothing we can do. The suit was not scheduled to be heard until August 2002, which meant the options would expire before we would know about the Environment Agency lease (see timeline below). June 2001 Options bought November 2001 Lawsuit filed June 2002 Options maturity date August 2002 Hearings and ruling lawsuit Now June 2001 Options bought November 2001 Lawsuit filed June 2002 Options maturity date August 2002 Hearings and ruling lawsuit Now At this point, the Principal put a team together (including you, your Associate and your VP) to analyse the situation and recommend a decision. Your team asked the Principal what their chances were to obtain a lease. He said that before the lawsuit was filed, he thought he would obtain the lease for sure. However, given the current situation, he thought there was currently an overall 50% chance that the Environment Agency would grant the lease after the conservationists lawsuit was resolved in late August. Then your team asked about the value of the land. The Principal said that if REIT Co. did not obtain a lease, we would not be able to develop a ski resort and would have no alternative but to sell the land. The Principal estimates that in this case he would be able to get 8 million for the parcels. To further complicate the problem, his preliminary analysis of the best way to handle the property if a lease were obtained from the Environment Agency was not conclusive as the team doing the work left the firm. So the principal was considering two alternatives (1) sell the property without any development, or (2) have a third party contractor install access roads, sewers, three ski lifts, and build the first wing of the lodge designed for the area. The first alternative, selling the land, would undoubtedly take over a year until a buyer was found and the Principal estimated that the land would sell for 14 million. One reason the second alternative was attractive was that construction could be completed during that same year. The team knew of several contractors who could do a good job of organizing and managing the skiing activities. By selling the project after 1 year of operation, there was a good chance that considerably greater profit could be realized than with just the raw land, and without any significant change in the timing of the sale. The added cost for this development would be approximately 5 million. The critical factor was the popularity of the facility. REIT Co. felt confident that the resort would prove attractive to the intermediate and advanced recreational skier. However, popularity would depend on several factors, including the snow conditions, the quality of the ski runs etc. So the team had worked up two sets of figures, one assuming a good reputation and the other assuming a poor reputation: Reputation Selling Price Good 21.8 million Poor 16.3 million The Principal was quite confident that the resort would have a good reputation, and estimated the likelihood of this to be at least 75%. If REIT Co. decided not to follow through on the White Mountain property, it had an option to participate in another development, which would result in a certain 1.5 million profit. Question

1. The emergency meeting- 10 points The Principal has scheduled an emergency meeting with the board of directors of REIT Co: He asks you to find the best course of action under the current circumstances. Make a decision tree and provide a complete recommendation for REIT Co. All numbers are already in PV terms in the case (i.e. you do not need to discount for this question).

Question 2. Financial Option -20 points You are asked to price a 3 period American put option with a strike of 20, up and down factor of 15% and yearly interest rate 3%. There are 3-time steps before maturity as the option matures in 9 months time. The share price is $10 currently.

Question 3. Betas 20 points Table 1 gives monthly returns for the London FT Index (the market), for Tesco Plc shares and for Beazer Plc shares. (Monthly returns measure the proportional increase in asset value from month to month, usually expressed on the log scale). Table 2 gives the results of carrying out linear regression with the market returns as the independent variable and the Tesco returns as the dependent variable.

a) Write out the regression equation relating these returns (for Table 2 only). 2 points

b) Is the coefficient for the Tesco returns (the Beta) significantly different from zero? Is it significantly different from 1? 2+2 points

c) What does the Tesco Beta tell us in a financial context? 1 point

d) Explain what it would mean if this coefficient was exactly equal to 1 from a financial perspective. 1 point

e) What does the quantity called Std. Error of Est tell us from both an econometrics and financial perspective? 1 point Table 3 gives the results of linear regression with market returns as the independent and returns for Beazer as the dependent variable.

f) Write out the regression equation. 1 point

g) Give a 95% confidence interval for the Beazer Beta. Is the coefficient significantly different from zero? From 1? (Approximate answers based on confidence interval will do). Remember to explain what it means from a financial perspective. 2+2+1 points

h) Explain what the coefficient for Beazer returns tells us? 1 point

i) Compare the equation for Tesco returns with the equation for Beazer returns. If you were risk-averse, which company would you choose to invest in on the evidence of this data? Explain your choice. 1 point Table 4 gives the results of regressing Beazer returns on the market returns, but based on data for the years 1982-1985 (Table 4.A) and 1986-1989 (Table 4.B).

j) Write out the two regression equations. 1+1 points k) Compare the results of Tables 4.A and 4.B. What do you observe? Suggest an explanation. 1 point