Recreational property acquires land parcels or property with recreational potential; they consolidate several parcels and obtain leases from the European Union Environmental Agency and create desirable recreational facilities. After acquiring the land, they either develop it themselves, or they sell it to another developer. Anders wants to obtain a set of land parcels in the White Mountain range, however, before obtaining the lease a group of conservationists blocked the authorization of the lease claiming that the lease would have negative impacts on the environment. All agencies have not been of help to him as they all tell him to wait for the suit to be heard.
Before the lawsuit Anders was 100% of getting a lease but given the current condition, the possibility has dropped to 50%. He obtained the land at £10 but if he fails to acquire the lease, he will sell it at £8 million which would mean a resulting loss of £2 million.
If he obtained the land, he would have two options, either to sell the land at £14 which would take him more than one year to develop or to sell the land within the same year. The additional costs to develop the land were estimated to be £5 million. If the park had a good reputation, it would sell at £21.8 million but if it had a bad reputation, it would sell at £16.3 million. Anders was 75% sure that the park would have a good reputation. He could choose to abandon White Mountain and follow another plan with certain £1.5 million.
On this case, Anders is faced with two tasks, it is upon him to decide the best course of action, he can either choose to follow the White Mountain project or he can choose to abandon it and engage himself on the other project with certain £1.5 million. If he chooses to follow the White Mountain project, Anders can either develop the land after acquiring it or he can sell it at cash price.
The best investment that that would be convincing to the agency to give Anders a lease was to create a green park for skiing, this is a park that is covered with vegetation except for the runways. The park is environmentally friendly since it discourages cutting down the trees. The green park also encourages people to plant more vegetation so that it can be more enjoyable. This would reduce the conservationists worry about possible destruction of vegetation and water sources at White Mountain.
The first risk that Anders faces is a lack of lease; he might fail to acquire the lease that would lead to a loss. The second risk that he faces is in case the recreational property earns a bad reputation. Although it is less probable that the park would earn a bad reputation, there are still chances of the same happening.
As it stands, it is better to continue with the lease acquisition plan and develop the establishment. The lease acquisition plan seems to have higher hopes of returns since:
Expected cost of development = 5m
Expected percentage of a good reputation =75%
Hence the expected outcome = 21.8 × 75%-5 = 16.8 m
While if the results are adverse
Expected income= 16.3m
Percentage in probability= 25%
Hence profit would be 16.3*0.25-5 = 11.3
11.35 m is a higher range than the expected amount if he sells the property without a developing it mostly because of the time he will have to wait. If he chooses to sell the land with no developments, he will have to wait until the next year but if he develops it, he will sell it on the current year.
The original profit value of the establishment was 10m, as a result of the lawsuit; the value has dropped to 8m there is a 2m drop in the value of the expected profits.
Since Anders had overestimated the probability of obtaining a lease, it, therefore, means that there is a higher risk of loss in the long term. The loss will be accelerated by the fact that the probability of getting a lease will be lower. If he manages to get a lease, Anders will have estimated that the probability of having good reputation was 75%, this was an inflated value and it was bound to be lower than this.
If the new probability of getting a lease was above 40% and that of getting a good reputation above 50%, it would be recommended that he continues to pursue the project as it would still have chances of being profitable.
After one year, the decision about the case will have been made; this increases the chances of making a more decision. If Recreation Properties defend their case in court, they will get the lease. In one year time, they will be decided on whether to develop or to sell the property.
If the extension for one year is followed up, the value would drop to 7 million
50%*14000000= 7000000
This would increase the risk if the company fails to secure the lease and is forced to sell the property that would mean that there would be a loss in 3million and the 1.5 million on the side project. This would result to total loss of 4.5 m.
A six months extension would not get Anders to the decision date, and hence he was still on great risk if the court gave an unfavorable decision. 565000 would be a reasonable amount since it would have accounted for 20% of the minimum amount that could be obtained. A six month extension is relatively expensive compared to the one year extension.
Anders should accept the offer; this is because it will reduce the chances of loss in case he is given the lease. If the probability of having a favorable court ruling is more than 50%, then it would be wise to buy the extension as there will be no risk.
