Flexibility and Real Estate Valuation under Uncertainty

1Discounted Cash Flow Valuation: The Basic Procedures and Concepts Underlying Spreadsheet Valuation Constitute the Springboard to our Approach of Analyzing Flexibility Under Uncertainty

LEARNING OBJECTIVES

• Share the reasons why we focus on the discounted cash flow (DCF) model;
• Establish the basic terminology and setup that we use throughout the text;
• Review the mechanics of the DCF valuation model;
• Understand the use of the DCF model for prospective (ex‐ante) and retrospective (ex‐post) valuations.

OUTLINE OF THE CHAPTER

• 1.1 Why the Focus on the Discounted Cash Flow Model?
• 1.2 Structure of a Discounted Cash Flow Spreadsheet
• 1.3 The Cash Flow Projection
• 1.4 Discount Rate
• 1.5 Market Value and Forward‐Looking (Ex‐Ante) Analysis
• 1.6 Backward‐Looking (Ex‐Post) Analysis
• 1.7 Conclusion

The focus of this book is on the valuation of properties and development projects in the face of uncertainty. We concentrate particularly on management and design flexibility, which is the ability to respond to circumstances in order to reduce downside risks and take advantage of upside opportunities.

To this end, everything in this book builds on and uses the basic discounted cash flow (DCF) model. So, to ensure we’re all on the same page, and using the same terminology and basic understanding about this tool, this first chapter introduces and reviews the DCF model, and thereby sets the stage for all that follows.

First, we discuss why it makes sense for us to focus on the DCF model. ...