Adosonic Reality is considering the construction of a new development of condominiums in downtown Austin, Texas. The site for the new development is currently occupied by an office building owned by the city. The project's profitability will depend largely on the population increase in Austin over the next several years. Rather than buy the site, Adosonic Reality has entered into an agreement with the city to pay $200,000 for the right to purchase the site for $10 million two years from now. The real option embedded in this contract is best described as:

Question

Quizplus · Accepted Answer

The real option embedded in this contract is the option to defer investment. Adosonic Reality has the right but not the obligation to purchase the site for $10 million two years from now. This means that if the population growth in Austin does not meet their expectations, they can choose not to exercise the option and not invest in the condominium development. Therefore, the real option embedded in this contract allows Adosonic Reality to defer their investment decision until they have more information about the profitability of the project.

Adosonic Reality Is Considering the Construction of a New Development