Reference no: EM13729835
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 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 firm’s tax rate is 30%
OPTION 2:
Lease the land to the developer in exchange for the use of 12,000 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.
Calculate the initial cost outlay of option 1
12,000,000
86,200,000
85,000,000
Calculate the initial cost outlay for option 2
350,000
1,200,000
85,000,000
Calculate the Weighted Cost of Capital (WACC)
6%
6.2%
8%
Calculate the annual revenue expected for option 1
180,000
9,900,000
10,080,000
Calculate the annual benefit expected for option 2
264,000
300,000
2,640,000
Calculate the annual depreciation expense for option 1
2,179,485
8,500,000
10,000,000
Calculate the annual depreciation expense for option 2
0
120,000
135,000
Calculate the salvage value you would take into consideration for option 1 in year 10
2,179,487
42,500,000
63,205,128
Calculate the salvage value you would take into consideration for option 2 in year 10
1,200,000
30,770,000
10,000,000
For option 1, calculate the operating cash flows for years 2-9
4,900,359
7,079,846
10,080,000
For option 1, calculate the operating cash flow for year 10
43,589,743
50,669,589
70,284,974
For option 2, calculate the operating cash flows for years 2-9
1,841,000
2,630,000
5,000,000
For option 2, calculate the operating cash flow for year 10
3,041,000
3,500,000
3,800,000
Calculate NPV for option 1
-1,679,769
-1,681,617
2,179,487
Calculate NPV for option 2
11,911,969
14,523,000
15,556,020
Which option should you choose?
Option 1
Option 2