You consider buying a lot on which you will build a small apartmentcomplex. The asking price for the lot is $500,000 and the estimated cost to buildthe apartment complex is $1,000,000 (construction should take one year). One yearfrom the date you intend to purchase the lot the city is going to make an importantdecision regarding the use of the land just across from your lot. You believe thatthere is a 30% chance that the decision would be favorable to you and a 70% chancethat it would be unfavorable. In case of a favorable or unfavorable outcome yourcomplex should generate an NOI of $250,000 or $200,000 respectively. Forsimplicity, you may assume that at any time you can sell your complex for a 9%CAP and your required rate of return is 10%.

a. Calculate the value of the lot using the traditional approach.

b. Calculate the value of the lot using the real option approach.

c. Should you buy the lot?

d. In case that you decided to buy the lot, should you build the apartmentcomplex right away or wait for the city to make its decision first? Why?