2. (25 points) A real estate developer is considering a project with the financi

Question

2. (25 points) A real estate developer is considering a project with the financial profile listed below. Complete a Discounted Cash Flow analysis and make a recommendation as to whether the development will be profitable, Cost of land acquisition at time zero, $1,400,000 for land, $100,000 other fees Construction takes 3 years, financed with $7,500,000 construction loan, paid for by setting aside $2,500,000 for 3 years and paying the interest at the time of project completion. Construction loan interest rate 7.5%. No fee for the loan . Opportunity cost of capital 20% in development phase Lease-up is 2 years; cash flows $100,000, $300,000 1.1 Opportunity cost of capital 3% higher in lease-up phase than for stable operations. . Property fully operational in year 6, net cash flow of $700K, growing at 2% per year. Discount rate of 7% for fully operational property.

Explanation / Answer

CF0= -$1,500,000 ($1,400,000 + $100,000)

CF1=$-2,500,000

CF2=-$2,500,000

CF3=-$3,625,000 ($2,500,000+$1,125,000)

* Total Interest = 0.075*$7,500,000 + 0.075*$5,000,000 + 0.075*$2,500,000

CF4=$100,00

CF5=$300,000

CF6 =$700,000

CF7 onwards growth rate is 2%

Terminal Value at year end of 6th year = $14,280,000 ($700,000*1.02/(0.07-0.02))

For CF1, CF2, CF3, discount factor is 20%, For CF4,CF5 discount factor is 10% (7% for stable operation +3%) and for CF6 onwards discount factor is 7%

PV0 =-1,500,000

PV1 = -$2,500,000/1.2 = -$2,083,333

PV2 = -$2,500,000/1.2^2 = -$1,736,111

PV3 = -$3,625,000/1.2^3 = -$2,097,801

PV4 = $100,000/1.1^4 = $68,301

PV5 =$300,000/1.1^5 = $186,276

PV6 =($700,000 + $14,280,000)/1.07^6 = $9,981,806

Sum of all present values is $2,819,139

Since NPV is positive, development is profitable

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