Your firm owns a lot in center city Philadelphia. The purchase price of the lot
ID: 2642081 • Letter: Y
Question
Your firm owns a lot in center city Philadelphia. The purchase price of the lot in 2002 was $350,000 and today its market value is 1.2 million
Your job is to determine which of the following two options would add the most value to the firm.
OPTION 1:
Build an office high rise with 450,000 square feet of office space. The street level will be dedicated to retail.
Expected revenues per square foot of office space is $22
Retail space is expected to rent for $180,000 a year.
The cost of the building is $85 million, it will be depreciated over 39 years (ignore year rule) and will be financed by borrowing $40,000,000 and paying the balance with cash. The cost of debt is 6% and the cost of cash 8%. (The cost of cash is the forgone return from investment). The firms tax rate is 30%
OPTION 2:
Lease the land to the developer in exchange for the use of 120,000 square feet of office space
The annual expenses for this option is $10,000 a year
Evaluate the two options over a useful life of 10 years.
1) Calculate the initial cost outlay of option 1
a. 12,000,000
b. 86,200,000
c. 85,000,000
2) Calculate the initial cost outlay for option 2
a. 350,000
b. 1,200,000
c. 85,000,000
3) Calculate the Weighted Cost of Capital (WACC)
a. 6%
b. 6.2%
c. 8%
4) Calculate the annual revenue expected for option 1
a. 180,000
b. 9,900,000
c. 10,080,000
5) Calculate the annual benefit expected for option 2
a. 264,000
b. 300,000
c. 2,640,000
6) Calculate the annual depreciation expense for option 1
a. 2,179,487
b. 8,500,000
c. 10,000,000
7) Calculate the annual depreciation expense for option 2
a. 0
b. 120,000
c. 135,000
8) Calculate the salvage value you would take into consideration for option 1 in year 10
a. 2,179,487
b. 42,500,000
c. 64,405,128
9) Calculate the salvage value you would take into consideration for option 2 in year 10
a. 1,200,000
b. 30,770,000
c. 10,000,000
10) For option 1, Calculate the operating cash flows for years 1-9
a. 4,900,359
b. 7,079,846
c. 10,080,000
11) For option 1, calculate the operating cash flow for year 10
a. 43,589,743
b. 50,669,589
c. 71,484,974
12) For option 2, calculate the operating cash flows for years 1-9
a. 1,841,000
b. 2,630,000
c. 5,000,000
13) For option 2, calculate the operating cash flow for year 10
a. 3,041,000
b. 3,500,000
c. 3,800,000
14) Calculate NPV for option 1
a. -1,679,769
b. 709,987
c. 2,179,487
15) Calculate NPV for option 2
a. 12,880,009
b. 14,523,000
c. 15,556,020
16) Which option should you choose?
a. Option 1
b. Option 2
Explanation / Answer
1. Calculate the initial cost outlay of option 1
85,000,000
2. Calculate the initial cost outlay for option 2
1,200,000
3. Calculate the Weighted Cost of Capital (WACC)
6.2%
4. Calculate the annual revenue expected for option 1
10,080,000
5. Calculate the annual benefit expected for option 2
2,640,000
6. Calculate the annual depreciation expense for option 1
2,179,487
7. Calculate the annual depreciation expense for option 2
0
8. Calculate the salvage value you would take into consideration for option 1 in year 10
64,405,128
9. Calculate the salvage value you would take into consideration for option 2 in year 10
1,200,000
10. For option 1, Calculate the operating cash flows for years 1-9
7,079,846
11. For option 1, calculate the operating cash flow for year 10
71,484,974
12. For option 2, calculate the operating cash flows for years 1-9
1,841,000
13. For option 2, calculate the operating cash flow for year 10
3,041,000
14. Calculate NPV for option 1
-1,679,769
15. Calculate NPV for option 2
12,880,009
16. Which option should you choose?
Option 2
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