Question: Previous problem: On a certain parcel of land, you can build a project worth $2 million today,for a construction cost of $1.8 million. If you wait and do not build the project until next year,the project would most likely be worth $2.2 million, and the construction cost would be $1.9 million. If investors require a 25% expected return for holding land, what is the value of the land today? Should you build the project today or wait until next year?
Problem waiting to be answered: In the above question, suppose there is a 50% chance that the project next year will be worth $2.6 million and a 50% chance that it will be worth only $1.8 million, with the construction cost still cost $1.9 million in both cases. The project today would certainlu be worth $2 million and cost $1.8 million, as above.
a. Under these circumstances(and still assuming a 25% required return on land), how mnuch is the land worth today?
b. Briefly discuss why the land is worth more in this problem than in the previous problem. Also explain briefly why is it better not to build the project today even though there is a 50% chance the project will be unprofitable next year.