Explain the Valuation of Vacant Land

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The Answer is Vacant land has value,because it represents an option to turn it into developed land.For example,a particular plot of land may be developed into an apartment block,an office building or a shopping mall.In the future,the developer will have an incentive to develop the property for the use that maximizes the difference between the value of the project's future revenues and its construction costs.However,the best possible future use for the land may not be known at present.The real options approach can be used to determine the worth of an option to construct one of a number of possible buildings with strike prices equal to the building's construction costs.One can value this option,and thus the land,by first computing the risk-neutral probabilities associated with various outcomes.One derives these probabilities from the observed market prices of traded investments (for example,the price of existing apartments and the risk-free rate of interest).Calculating these risk-neutral probabilities requires solving for probabilities that generate expected cash flows for traded assets that equal their certainty equivalent cash flows.In other words,with the correct risk-neutral probabilities,the expected cash flows of traded assets,discounted at the risk-free rate,will equal the observed market price of the traded asset.These same risk-neutral probabilities can then be applied to the cash flows of the investment being valued to calculate the risk-neutral (or certainty equivalent)cash flows,which are then discounted at the risk-free rate.

Explain the Valuation of Vacant Land

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