An analysis of the use of discounted cash flow methods and real options to value flexibility in real estate development projects

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dc.contributor.advisorCorreia, Carlosen_ZA
dc.contributor.authorBauer, Michaelen_ZA
dc.date.accessioned2014-07-31T12:14:16Z
dc.date.available2014-07-31T12:14:16Z
dc.date.issued2007en_ZA
dc.descriptionIncludes abstract.
dc.descriptionIncludes bibliographical references (leaves 68-71).
dc.description.abstractSurveys of firms outside the property sector indicate the growth in the use of DCF methods such as the NPV and IRR methods to evaluate projects as compared to the use of such naïve methods as Payback and the Accounting rate of return. The growing convergence of theory and practice is indicated by the growing use of the NPV method. The objective of this study is to determine the capital budgeting methods used to evaluate real estate development projects and to compare the results of a survey with the results of other studies. Further, recent developments in capital budgeting theory, indicate that the investment valuation tools such as the Net Present Value (NPV), Internal Rate of Return (lRR), Payback Period (PP), and theAccounting Rate of Return (ARR) may fail to recognize flexibilities in real estate development projects. As a consequence, the discounted cash flow methods (DCF) may systematically undervalue strategic or large-scale real estate development projects. Two methods are introduced as an alternative to address the weaknesses of the DCF methods. Decision Tree Analysis (DTA) employs an approach to analyse flexibilities by creating a chain of possible options and allows alternative courses of action for management to adapt their initial strategies in order to capitalise on new opportunities or to minimise losses. Real Option Analysis (ROA) introduces the theory of valuing financial derivates, in particular call options, and allows the staging of the development. These instruments further introduce a risk management aspect, as call options have a limited down side and an unlimited upside. Each approach has advantages and shortcomings and should only be used in appropriate circumstances. DTA is suited for the analysis of the project specific risks. ROA on the other hand, is a superior tool when dealing with uncertainty. The thesis finds that that over 90% of all respondents are using a combination of NPV and IRR methods most often to evaluate development opportunities. Interestingly, 85% of all respondents are also using the payback period. Other methods used are the profitability index, residual value, free cash flow, economic value, and return on equity. Developers have adopted DCF methods such as NPV and IRR as the primary methods to evaluate projects rather than naïve methods such as Payback and ARR, although these latter methods remain in use. The use of decision tree analysis and real option analysis is very limited.en_ZA
dc.identifier.apacitationBauer, M. (2007). <i>An analysis of the use of discounted cash flow methods and real options to value flexibility in real estate development projects</i>. (Thesis). University of Cape Town ,Faculty of Commerce ,College of Accounting. Retrieved from http://hdl.handle.net/11427/5628en_ZA
dc.identifier.chicagocitationBauer, Michael. <i>"An analysis of the use of discounted cash flow methods and real options to value flexibility in real estate development projects."</i> Thesis., University of Cape Town ,Faculty of Commerce ,College of Accounting, 2007. http://hdl.handle.net/11427/5628en_ZA
dc.identifier.citationBauer, M. 2007. An analysis of the use of discounted cash flow methods and real options to value flexibility in real estate development projects. University of Cape Town.en_ZA
dc.identifier.ris TY - Thesis / Dissertation AU - Bauer, Michael AB - Surveys of firms outside the property sector indicate the growth in the use of DCF methods such as the NPV and IRR methods to evaluate projects as compared to the use of such naïve methods as Payback and the Accounting rate of return. The growing convergence of theory and practice is indicated by the growing use of the NPV method. The objective of this study is to determine the capital budgeting methods used to evaluate real estate development projects and to compare the results of a survey with the results of other studies. Further, recent developments in capital budgeting theory, indicate that the investment valuation tools such as the Net Present Value (NPV), Internal Rate of Return (lRR), Payback Period (PP), and theAccounting Rate of Return (ARR) may fail to recognize flexibilities in real estate development projects. As a consequence, the discounted cash flow methods (DCF) may systematically undervalue strategic or large-scale real estate development projects. Two methods are introduced as an alternative to address the weaknesses of the DCF methods. Decision Tree Analysis (DTA) employs an approach to analyse flexibilities by creating a chain of possible options and allows alternative courses of action for management to adapt their initial strategies in order to capitalise on new opportunities or to minimise losses. Real Option Analysis (ROA) introduces the theory of valuing financial derivates, in particular call options, and allows the staging of the development. These instruments further introduce a risk management aspect, as call options have a limited down side and an unlimited upside. Each approach has advantages and shortcomings and should only be used in appropriate circumstances. DTA is suited for the analysis of the project specific risks. ROA on the other hand, is a superior tool when dealing with uncertainty. The thesis finds that that over 90% of all respondents are using a combination of NPV and IRR methods most often to evaluate development opportunities. Interestingly, 85% of all respondents are also using the payback period. Other methods used are the profitability index, residual value, free cash flow, economic value, and return on equity. Developers have adopted DCF methods such as NPV and IRR as the primary methods to evaluate projects rather than naïve methods such as Payback and ARR, although these latter methods remain in use. The use of decision tree analysis and real option analysis is very limited. DA - 2007 DB - OpenUCT DP - University of Cape Town LK - https://open.uct.ac.za PB - University of Cape Town PY - 2007 T1 - An analysis of the use of discounted cash flow methods and real options to value flexibility in real estate development projects TI - An analysis of the use of discounted cash flow methods and real options to value flexibility in real estate development projects UR - http://hdl.handle.net/11427/5628 ER - en_ZA
dc.identifier.urihttp://hdl.handle.net/11427/5628
dc.identifier.vancouvercitationBauer M. An analysis of the use of discounted cash flow methods and real options to value flexibility in real estate development projects. [Thesis]. University of Cape Town ,Faculty of Commerce ,College of Accounting, 2007 [cited yyyy month dd]. Available from: http://hdl.handle.net/11427/5628en_ZA
dc.language.isoengen_ZA
dc.publisher.departmentCollege of Accountingen_ZA
dc.publisher.facultyFaculty of Commerceen_ZA
dc.publisher.institutionUniversity of Cape Town
dc.subject.otherReal Estate Investment Analysis|real option analysis|property development|strategic risk managementen_ZA
dc.titleAn analysis of the use of discounted cash flow methods and real options to value flexibility in real estate development projectsen_ZA
dc.typeMaster Thesis
dc.type.qualificationlevelMasters
dc.type.qualificationnameMComen_ZA
uct.type.filetypeText
uct.type.publicationResearchen_ZA
uct.type.resourceThesisen_ZA
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