As the Senior Portfolio Management Analyst youve been asked by your Portfolio Manager to

research an airport, a seaport and a toll bridge for potential inclusion as a 5% weighting in a

government defined benefit pension plan portfolio. The holding period is 30 years.

The airport will have an effective gross income of $30 million over the next year and

operating expenses that are 20% of effective gross income over the forecast horizon after being

$10 million this year due to a major renovation. The effective gross income is expected to

continue to grow at the rate of the local economy which is a steady 3.25%. A going-in cap rate

based on some fairly stale comparables in this highly illiquid market is 6.75% and the going-out

cap rate is forecast to be the same.

The seaport enjoyed $38 million in effective gross income last year but this will only

grow at 1% a year due to deglobalization effects. Last year operating expenses were $9.5

million but they are expected to grow at the local rate of inflation of 7.5% which will decline

linearly in time before hitting the central bank target of 2% (where it will remain thereafter) in

10 years time. The pension plan requires a 12% return on an asset like this and the going out

cap rate is expected to be 9% when the host country has completed its industrialization and

transition to a consumer economy.

The toll bridge had effective gross income last year of $65 million and will grow 4%

above the local inflation rate (targeted by the central bank) of 2% for the next six years but then

it will be slashed in half due to the completion of a competing bridge. Thereafter it will grow at

a real rate of 1%. Operating expenses were $9.75 million last year and will increase at the rate

of inflation over the forecast horizon except in years 10 and 11 when it will be $25 million in

each year due to a planned major upgrade required by new government regulations. The

going-in cap rate is 5% but is expected to be 9% upon exiting the position. The pension requires

an 8% return as compensation for bearing the risk involved.

Calculate the value of each of these properties but just as importantly your portfolio

manager wants you to produce margins of error where you assume each going-out cap rate

was off by 25%. Write a three to four page report broken into sections as follows: Introduction,

theory, analysis, discussion, conclusion and references. Which property has the largest margin

of error in absolute terms? Which has the largest in percentage terms? Which property are

you going to recommend to the portfolio manager?