Disney is considering entering into a joint venture to build condominiums in Vail, Colorado, with a local real estate developer. The development is expected to cost $1 billion overall and, based on Disney's estimate of the cash flows, generate $900 million in present value cash flows. Disney will have a 40% share of the joint venture (requiring it to put up $400 million of the initial investment and entitling it to 40% of the cash flows) but it will have the right to sell its share of the venture back to the developer for $300 million.
a. If the standard deviation in real estate values in Vail is 30% and the riskless rate is 5%, estimate the value of the abandonment option to Disney.
b. Would you advice Disney to enter into the joint venture?
c. If you were advising the developer, how much would he need to generate in present value cashflows from the investment to make this a good investment?