Malik Properties has three separate investment choices with a 16% corporate hurd

Question

Malik Properties has three separate investment choices with a 16% corporate hurdle rate and $60,000 to apply to capital investments. Choice 1 is to buy a lease on warehouse space for $30,000 that could be sublet to an already identified tenant generating net cash flows of $7,925 per year for 5 years paid at the start of each year. Choice 2 is to buy a lease on one or two fast food restaurants from an estate that is projected to settle in nine years. Each restaurant lease costs $20,000 and will generate net cash flows of $6,700 per year with all lease payments being made in arrears. Choice 3 is to buy units within a flexible space office building. There are currently 4 identical units available which can be acquired in any whole unit quantity for $10,000 per unit. Each unit is projected to generate net cash flows of $5,166.15 per year for seven years. How should Malik Properties proceed and why?

Explanation / Answer

Capital investments $60,000 Hurdle rate 16% Lease on warehouse Lease on restaurant Buy office units choice 1 Choice 2 Choice 3 year cash flows year cash flows year cash flows Hurdle rate@ 16% Present value of cash flows choice 1 Present value of cash flows choice 2 Present value of cash flows choice 3 0 ($30,000) 0 ($20,000) 0 -$40,000.00 1 7,925 1 6,700 1 20,664.60 0.862 6831.35 5775.4 17812.885 2 7,925 2 6,700 2 20,664.60 0.743 5888.275 4978.1 15353.798 3 7,925 3 6,700 3 20,664.60 0.641 5079.925 4294.7 13246.009 4 7,925 4 6,700 4 20,664.60 0.552 4374.6 3698.4 11406.859 5 7,925 5 6,700 5 20,664.60 0.476 3772.3 3189.2 9836.3496 6 6,700 6 20,664.60 0.41 25946.45 2747 8472.486 7 6,700 7 20,664.60 0.354 2371.8 7315.2684 8 6,700 0.305 2043.5 83443.655 9 6,700 0.263 1762.1 30860.2 NPV for choice 1 = -30,000+25,946.45 = -4,053.55 NPV for choice 2 = -20,000+30,860 = 10,860 NPV for choice 3 = -40,000+83,443.655 = 43,443.65 Choice 3 has the highest net present value hence advisable to select choice 3 based on net present value analysis.

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