Real Options Analysis in Valuation of Commercial Project : A Case Study

Case study analysis is used to examine the application of real options in valuing a commercial real estate mall project. Comparison of valuations using traditional discounted cash flow model with Black-Scholes, Binomial and Samuelson-McKean option models brings out the relevance of real option analysis in project decisions. Real options analysis is pertinent when market prices increase the strategic value of real estate development projects by incorporating fluctuations in volatility and providing project flexibility in its operations. The developers with varied project alternatives are able to execute the most desirable alternative using real options analysis. In real estate, land held by the developer tends to have a perpetuity value and it is at the discretion of the developer to execute possible options based on prevalent market conditions. Samuelson-McKean model that values the project as a perpetual American call option has computed the premium value of the commercial project as Rs. 154.08 mn, thus giving a strategic return of 85% to the developers