2. There\'s a piece of land (0.44 acres) on sale just off Kennedy Blvd, and you
ID: 2790194 • Letter: 2
Question
2. There's a piece of land (0.44 acres) on sale just off Kennedy Blvd, and you are thinking about buying the land, developing it into an office building and eventually selling it. The seller of the land asked for $600,000. The general contractor says that he can develop it for you and build the office in just one year. You plan to do a month-by-month capital budgeting and see if you should proceed with this investment. If you buy the land today, your cost is the price of the land plus 296 fee for titling, real estate broker, etc. Starting in month 1, your general contractor will take care of the rest, including site development and construction. He asks for $40,000 per month for everything. After 12 months, the building will be done and you will try to sell it for $2 million. Your income tax rate is 33%. You also agree to pay 5% to your real estate agent when it's sold. The appropriate discount rate for this project is 8% annually. Now you have all the numbers in front of you, you want to (1) Decide whether you should take this investment or not. (2) Create a NPV profile (3) Do a sensitivity analysis and scenario analysis to get a better picture of the risk you are facing. You are free to choose your own variables and create your own scenarios. (4) You might not be able to afford the cost of construction towards the end, you need to get a $100,000 loan from the bank. After talking to Fifth Third Bank, they agreed to offer you a 10-year loan of $100,000 with fixed monthly payments and floating interest rates. Your interest rates will be 3.5% for the first 2 years, 3.2% for the next 3 years, 3% for the last 2 years and 2.8% for the last 3 years. You want to create a loan amortization table to figure out what your payments look likeExplanation / Answer
1) THE PROJECT SHOLD BE TAKEN AS THE NPV IS POSITIVE.
2) NPV PROFILE OF THE PROJECT IS AS UNDER:-
OFFICE CONSTRUCTION PROJECT
YEAR
0
1
LAND COST -600000
ASSOCIATED COST-12000
CONSTRUCTION COST -480000 =(600000+12000+480000=1092000)
SALE OF OFFICE 2000000
LESS BROKERAGE @ 5% 100000
LESS COST OF OFFICE 1092000
PROFIT BEFORE TAX 808000
TAX @ 33% 266640
NET INCOME 541360
NET CASH FLOW 1092000+541360=1633360
OFFICE -1092000 1092000
PROFIT BEFORE TAXES 808000
TAX @ 33% 266640
NET INCOME 541360
NET CASH FLOW -1092000 1633360
DISCOUNTING RATE 8 %
NPV $ 389231.82
2) SENSITIVITY ANALYSIS AT 10% LOWER SALE PRICE OF OFFICE
OFFICE CONSTRUCTION PROJECT
YEAR
0
1
LAND COST -600000
ASSOCIATED COST -12000
CONSTRUCTION COST -480000
COST OF OFFICE -1092000
SALE OF OFFICE 1800000
LESS BROKERAGE @ 5% 100000
LESS COST OF OFFICE 1092000
PROFIT BEFORE TAX 608000
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