Abstract
Decision-making should be a value-based approach in any organisation, as it requires
discipline in assessing and making strategic and operating decisions necessary to
maximise shareholder wealth.
Business conditions in the construction industry are such that operations are burdened
with uncertainty and risk affected by time and events, especially in large-scale land
development projects where profit margins are small, but quantifiably material due to
the size of these projects. Risk assessment is a growing reality in the evaluation of
projects. It plays a defining and integral role within this type of project due to its nature,
and management has to ensure that the risks in their control are mitigated due to the
sensitivity of the uncertainties inherent therein.
Strategic flexibility is necessary when managing these projects as it allow managers
to recognise, plan and manage most uncertainties in such a way that it could
potentially alter and maximise project value. Large-scale developments carry many
uncertainties within their micro and macroeconomic environment which if not managed
correctly, could materially alter its profitability. A fluctuation in material costs, interest
rates, inflation, labour unrest, political changes and geotechnical setbacks are the type
of uncertainties characteristic to such developments.
The decision to invest in large-scale land developments is predominantly based on the
traditional methods of capital budgeting. The more familiar methods are: the return on
investment method, the internal rate of return method, the net present value method
and the payback method. These methods carry inherent limitations that do not
consider any reaction to changes over the development period when uncertainties and
opportunities are present. These traditional valuation methods also don’t account for
any risk factors, and allow for managerial flexibility at points where critical decisionmaking
has to be made. Other methods of capital budgeting have been developed in
order to address these limitations such as decision trees, simulations, sensitivity
analysis and more importantly, real option valuations which are the key focus in this
paper...
M.Com. (Financial Management)