It was three o’ clock on a hot afternoon in Hong Kong in mid-2000. Larry Yung, Chairman of Citic Pacific Limited (“CPL”), was having a board meeting with his property development team. From his window on the 33rd floor of Citic Tower, he could see the impressive Victoria Harbour and an undeveloped prime waterfront site. This piece of reclaimed land had been purchased by a company six months earlier at a public auction. Now, the owner wanted to dispose of it, and hence it was made available to CPL on a first-choice basis through an intermediary. Larry thought CPL could acquire the site and develop it into another Grade A office building in Central — he planned to call it “Citic Tower II”. The asking price of the land was HK$1 billion, and the estimated scale of the building and development costs were comparable to those of Citic Tower. Larry personally wanted to give this deal the go-ahead, but he was hesitant to commit his company to this two-to-three year project without seeking advice from his management team. At the board meeting, Larry leaned back in his chair and riffled through the feasibility report he had been given. To his disappointment, investing in Citic Tower II did not seem to bring about clear positive returns. Under the rigid assumptions set by the property development team and the Net Present Value Rule, the project reflected a present value of around HK$1.54 billion and a cost of around HK$1.6 billion. Larry intuitively felt that the decision was too deterministic, as it did not allow for any flexibility, managerial discretion or strategic actions. Should he allow the board to reject or go ahead with this project based on discounted cashflow (DCF) analysis alone? If the decision to develop was delayed or otherwise changed, would the full potential of this development opportunity be substantially better than the analysis suggested? Background
Citic Pacific Limited was incorporated in Hong Kong and listed on the Hong Kong Stock Exchange in 1991. In 2000, infrastructure and related assets formed the cornerstone of CPL’s activities, ranging from civil facilities such as complex bridge, road and tunnel facilities to power generation, environmental projects, aviation and telecommunications. CPL owned extensive trading and distribution interests, particularly in the motor industry, through its Mary Ho prepared this case under the supervision of Dr. Frederik Pretorius for class discussion. This case is not intended to show effective or ineffective handling of decision or business processes. Although the utmost care has been taken in preparing the history and fundamental background in this case, the investment decisions under consideration here are fictitious but typical. The opportunity discussed in this case does not represent an actual specific company opportunity, nor is the hurdle rate for investment property intended to represent actual company hurdle rates at the time of writing. This case is part of a project funded by a teaching development grant from the University Grants Committee (UGC) of Hong Kong. © 2002 by the Centre for Asian Business Cases, The University of Hong Kong. No part of this publication may be reproduced or transmitted in any form or by any means - electronic, mechanical, photocopying, recording, or otherwise (including the Internet) - without the permission of The University of Hong Kong. Ref. 02/136C 16 July, 2002
￼CITIC Tower II: The Real Option
02/136C Citic Tower II: The Real Option
￼wholly owned subsidiary, Dah Chong Hong Limited. It also had stakes in firms such as Cathay Pacific, Dragonair and a string of trading and property companies. Given the cyclical nature of the market, CPL’s property revenues were significantly less predictable than the revenues from the company’s infrastructure assets, where high proportions of its revenues were contractually defined and recurrent. Property investment projects were generally based on 12 per cent required return...
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