If KF decides to build a facility, it would need a 50 acre site by 31 December 2012 (t=0). KF already owns a suitable site which cost $500,000 several years ago, and can now be sold for $2million after all expenses have been deducted. Other suitable sites can also be purchased for $2million. KF can obtain an option on a similar site in the same area for $100,000 on 31 December 2012. The option would give KF the right to purchase the site for $2.6million on 31 December 2017. It is estimated that similar sites will then have a market value of $2million. The WACC is 10%, adjusted 3% up or down for more or less risk.
In terms of the land acquistion, what cost if any should be attributed to the project and why?
Calculate the present value of purchasing the option now and compare it with the present value of purchasing the land outright later on. Which is the better alternative and why?