Abstract
The issue of application of real option valuation approach in the valuation of investment project is presented in the article in a way in which the flexibility of the project could be included in the process of its valuation. The authors apply the valuation approach in case of a specific investment project in the real estate in the capital city of the Czech Republic—Prague, using the option to expand, to contract, and to abandon the project. The main aim of this case study is to present a practical application of the investment valuation and to construct an option pricing model for real estate investment which considers and integrates as many aspects of the investment and market environment as possible to describe the best situation of the real estate market and its development. The valuation of the investment is carried out using a universally applicable numerical method of binomial trees. The results obtained are subjected to the sensitivity analysis with respect to the discount rate, value of the most influential parameter of the volatility and the input option parameters. The results of the valuation of the project obtained using the real option approach are important mainly for the management of the company in the process of quantification of the present value of future investments. Implementation of managerial interventions enables for optimizing the value of the project not only in case of favourable development of the real estate market, but particularly in case of unfavourable development. Therefore, they are important in order to protect an investor from potential high losses. Finally, the valuation of these interventions increases the present value of the project, contributing to the decision of the corporate management regarding its implementation.
Highlights
The real option valuation, based on the principles of the financial option valuation, has been considered to be one of the most widely applied valuation approaches for some years, in the area of real estate investment valuation
A common feature of these studies is that the investment valuation methods based on the discounted cash flows are not appropriate tools for evaluating investment projects in the real estate, as we have demonstrated in this case study
By applying the combined real option to choose, we evaluated the project of investment into the real estate situated in the capital city of the Czech Republic, Prague
Summary
The real option valuation, based on the principles of the financial option valuation, has been considered to be one of the most widely applied valuation approaches for some years, in the area of real estate investment valuation By applying this methodology, it is possible to quantify the value of flexibility of managerial interventions during the existence of the project. The real option valuation follows the dynamic methods of investment evaluation that consider the relationship between the value of initial investments and expected cash flows in their present value that the project is able to generate during its existence They do not take into account any possibility to make managerial interventions during the existence of the project. The inclusion of the value of real options representing the right to implement intervention in the project greatly increases the value of the project itself
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