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Deck 13: Real-Options Analysis
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Question
You are considering an investment in a tree farm. Trees grow each year by the following factors: 
The price of lumber follows a binomial lattice with 
0. The interest rate (risk-free) is constant
at 6%. It costs $2 million each year, payable at the beginning of the year, to lease the forest land. The initial value
of the trees is $5 million (assuming they were harvested immediately). You can cut the trees at the end of any
year and then not pay rent after that. With rent of $2 million per year, find the best cutting policy and the value
of the investment opportunity.
The price of lumber follows a binomial lattice with 0. The interest rate (risk-free) is constantat 6%. It costs $2 million each year, payable at the beginning of the year, to lease the forest land. The initial value
of the trees is $5 million (assuming they were harvested immediately). You can cut the trees at the end of any
year and then not pay rent after that. With rent of $2 million per year, find the best cutting policy and the value
of the investment opportunity.
Question
A Korean auto-part supplier is evaluating an investment project to build a manufacturing plant close to Kia
Automobile Assembly Plant near West Point, Georgia. The supplier can obtain a 1-year option to buy the
required parcel of land near West Point area and if the land is purchased the price would be $1,500,000. The
land option, if purchased, would expire 1-year from now. The supplier has two years to make a decision on
whether to build the plant and start operations, once the land was purchased. The required capital investment
would be $5,000,000. They estimate that the land, if purchased, could be sold for 110% of its purchase price
anytime over next two years.
What would the company be willing to pay for the combined value of the land option?
Automobile Assembly Plant near West Point, Georgia. The supplier can obtain a 1-year option to buy the
required parcel of land near West Point area and if the land is purchased the price would be $1,500,000. The
land option, if purchased, would expire 1-year from now. The supplier has two years to make a decision on
whether to build the plant and start operations, once the land was purchased. The required capital investment
would be $5,000,000. They estimate that the land, if purchased, could be sold for 110% of its purchase price
anytime over next two years.
What would the company be willing to pay for the combined value of the land option?
Question
Value an American put option using a binomial lattice with the following attributes: 
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Deck 13: Real-Options Analysis
1
Value a European call option using a binomial lattice with the following attributes:
• Current underlying asset value of 60
• Exercise price of 60
• Volatility of 30%
• Risk-free rate of 5%
• Time to expiration equal to 18 months
• A two-time period lattice
• Current underlying asset value of 60
• Exercise price of 60
• Volatility of 30%
• Risk-free rate of 5%
• Time to expiration equal to 18 months
• A two-time period lattice
2
You are considering an investment in a tree farm. Trees grow each year by the following factors: The price of lumber follows a binomial lattice with 0. The interest rate (risk-free) is constant
at 6%. It costs $2 million each year, payable at the beginning of the year, to lease the forest land. The initial value
of the trees is $5 million (assuming they were harvested immediately). You can cut the trees at the end of any
year and then not pay rent after that. With rent of $2 million per year, find the best cutting policy and the value
of the investment opportunity.
The price of lumber follows a binomial lattice with 0. The interest rate (risk-free) is constantat 6%. It costs $2 million each year, payable at the beginning of the year, to lease the forest land. The initial value
of the trees is $5 million (assuming they were harvested immediately). You can cut the trees at the end of any
year and then not pay rent after that. With rent of $2 million per year, find the best cutting policy and the value
of the investment opportunity.
3
A Korean auto-part supplier is evaluating an investment project to build a manufacturing plant close to Kia
Automobile Assembly Plant near West Point, Georgia. The supplier can obtain a 1-year option to buy the
required parcel of land near West Point area and if the land is purchased the price would be $1,500,000. The
land option, if purchased, would expire 1-year from now. The supplier has two years to make a decision on
whether to build the plant and start operations, once the land was purchased. The required capital investment
would be $5,000,000. They estimate that the land, if purchased, could be sold for 110% of its purchase price
anytime over next two years.
What would the company be willing to pay for the combined value of the land option?
Automobile Assembly Plant near West Point, Georgia. The supplier can obtain a 1-year option to buy the
required parcel of land near West Point area and if the land is purchased the price would be $1,500,000. The
land option, if purchased, would expire 1-year from now. The supplier has two years to make a decision on
whether to build the plant and start operations, once the land was purchased. The required capital investment
would be $5,000,000. They estimate that the land, if purchased, could be sold for 110% of its purchase price
anytime over next two years.
What would the company be willing to pay for the combined value of the land option?
4
Value an American put option using a binomial lattice with the following attributes:
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