RealEstates LLP 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, RealEstates 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 in this contract is the option to defer investment. RealEstates has the right, but not the obligation, to purchase the site for $10 million two years from now. This gives them the flexibility to wait and see if the population increase in Austin meets their expectations before committing to the development, reducing their downside risk.

RealEstates LLP Is Considering the Construction of a New Development