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What is the project's NPV, given the projections in Table 10.8?

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Waldo County, the well-known real estate developer, worked long hours, and he expected his;staff to do the same. So George Chavez was not surprised to receive a call from the boss just as;George was about to leave for a long summer's weekend.;Mr. County's success had been built on a remarkable instinct for a good site. He would exclaim;Location! Location! Location! at some point in every planning meeting. Yet finance was not;his strong suit. On this occasion he wanted George to go over the figures for a new $90 million;outlet mall designed to intercept tourists heading downeast toward Maine. First thing Monday;will do just fine, he said as he handed George the file. I'll be in my house in Bar Harbor if you;need me.;George's first task was to draw up a summary of the projected revenues and costs. The results are;shown in Table 10.8. Note that the mall's revenues would come from two sources: The company;would charge retailers an annual rent for the space they occupied and in addition it would receive;5% of each store's gross sales.;Construction of the mall was likely to take three years. The construction costs could be;depreciated straight-line over 15 years starting in year 3. As in the case of the company's other;developments, the mall would be built to the highest specifications and would not need to be;rebuilt until year 17. The land was expected to retain its value, but could not be depreciated for;tax purposes.;Construction costs, revenues, operating and maintenance costs, and real estate taxes were all;likely to rise in line with inflation, which was forecasted at 2% a year. The company's tax rate;was 35% and the cost of capital was 9% in nominal terms.;George decided first to check that the project made financial sense. He then proposed to look at;some of the things that might go wrong. His boss certainly had a nose for a good retail project;but he was not infallible. The Salome project had been a disaster because store sales had turned;out to be 40% below forecast. What if that happened here? George wondered just how far sales;could fall short of forecast before the project would be underwater.;Inflation was another source of uncertainty. Some people were talking about a zero long-term;inflation rate, but George also wondered what would happen if inflation jumped to, say, 10%.;A third concern was possible construction cost overruns and delays due to required zoning;changes and environmental approvals. George had seen cases of 25% construction cost overruns;and delays up to 12 months between purchase of the land and the start of construction. He;decided that he should examine the effect that this scenario would have on the project's;profitability.;Hey, this might be fun, George exclaimed to Mr. Waldo's secretary, Fifi, who was heading for;Old Orchard Beach for the weekend. I might even try Monte Carlo.;Waldo went to Monte Carlo once, Fifi replied. Lost a bundle at the roulette table. I wouldn't;remind him. Just show him the bottom line. Will it make money or lose money? That's the;bottom line.;OK, no Monte Carlo, George agreed. But he realized that building a spreadsheet and running;scenarios was not enough. He had to figure out how to summarize and present his results to Mr.;County.;QUESTIONS;1. What is the project's NPV, given the projections in Table 10.8?;2. Conduct a sensitivity and a scenario analysis of the project. What do these analyses;reveal about the project's risks and potential value?

 

Paper#25012 | Written in 18-Jul-2015

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