Framing the Decision
Recreational Properties obtained a package of options to acquire three parcels that would allow them to develop a ski resort. The company paid ˆ500,000 for the package of options in June 2001. The options gave the company the right, but not the obligation, to acquire the three parcels at a (strike) price of ˆ10 million in June 2002.
Furthermore, in order to develop the three parcels into a ski resort, the company needed leases from the European Union Environment Agency. When the company purchased the options, they expected the leasing agreement before December 2001.
Proposal for Reasonable Investment
From point 2, we’ve seen than securing the lease would allow the expected value to increase by 3.1725 million. This is therefore the maximum value we’re ready to pay based solely on the main expected value. Nevertheless, if the risk appetite is lower, we could calculate a value that ensures none of the options to have negative return. This value is equal to 1.3 million.
A one-way sensitivity analysis has been done first based on a whatif table and then, thanks to decision tree tools. This first analysis shows that the breakeven point is at 48%, meaning that if Anders is off by a few percents on his estimate on the result of the lawsuit, not exercising the options becomes the best choice. Regarding the reputation, the breakeven point occurs at 68% . We have some more margins in that case but the conclusions are the same. A two-way analysis shows the safest areas. The (50%- 75%) is close to grey area where a small offset in the probability might change the decision.
Based on here above comments, if it is not possible to assess more clearly the probability (by securing the lease or through a market.