Valuing a forest as a call option: The sale of Forestry Corporation of New Zealand

In September 1996, the New Zealand (NZ) Government sold its 100% shareholding in the Forestry Corporation of NZ (FC) to a consortium led by Fletcher Challenge Forests (FF), a publicly listed company, for NZ $2.06 billion. Option pricing methodology is used to value the forest assets that were listed in FC's 1996 Annual Report at $1.853 billion. Total net assets had a book value of $2.03 billion, about $30 million less than the selling price. Assuming a 7.5% real cost of capital and a maximum tax rate of 33%, the actual value of the forest assets realized in the sale (taken to be $1.853 billion) are at a 12.9% discount to the ‘fair’ value of $2.128 billion derived by the option pricing approach. The advantage of this approach to forest valuation over the traditional approach (based on discounted cash flow using projected future prices over long horizons) is that only the volatility of future log prices need be estimated. The relative insensitivity of forest value to this parameter suggests less spread between bid and ask prices by forest buyers and sellers with similar costs of capital, tax rates, and so on.