Problem $16-3$

As a financial advisor for the Spain Development Company, you have been given the construction and marketing studies for the

proposed Timbercreek office project. Several potential sites have been selected, but a final decision has not been made. Your

manager needs to know how much she can afford to pay for the land and still manage to return $16$ percent on the entire project over

its lifetime.

The strategic plan calls for a construction phase of one year and an operation phase of five years, after which time the property will be

sold. The marketing staff says that a $1\mathrm{.}3-$acre site will be adequate because the initial studies indicate that this site will support an office

building with a gross leasable area $($GLA$)$ of $26,520$ square feet. The gross building area $($GBA$)$ will be $31,200$ square feet, giving a

leasable ratio of $85$ percent. The marketing staff further assures you that the space can be rented for $$20\mathrm{.}4$ per square foot. The head

of the construction division maintains that all direct costs $($excluding interest carry and all loan fees$)$ will be $$3\mathrm{.}5$ million.

The First Street Bank will provide the construction loan for the project. The bank will finance all of the construction costs, site

improvements, and interest carry at an annual rate of $6$ percent plus a loan origination fee of $1\mathrm{.}5$ points. The construction division

estimates that the direct cost draws will be taken down in six equal amounts commencing with the first month after close. The

permanent financing for the project will come at the end of the first year from the Reliable Company at an interest rate of $5$ percent

with a $4$ percent prepaid loan fee. The loan has an eight$-$year term and is to be paid back monthly over a $25-$year amortization

schedule. No financing fees will be included in either loan amount. Spain will fund acquisition of the land with its own equity.

Spain expects tenant reimbursements for the project to be $$3\mathrm{.}95$ per square foot and the office building to be $75$ percent leased

during the first year of operation. After that, vacancies should average about $5$ percent of GPI per year. Rents, tenant reimbursement,

and operating expenses are expected to increase by $3$ percent per year during the lease period. The operating expenses are

expected to be $$10\mathrm{.}20$ per square foot. The final sales price is based on the $N\frac{O}{?}$ in the sixth year of the project $($the fifth year of

operation$)$ capitalized at $9\mathrm{.}5$ percent. The project will incur sales expenses of $4$ percent. Spain is concerned that it may not be able to

afford to pay for the land and still earn $16$ percent $($before taxes$)$ on its equity $($remember that the land acquisition cost must be paid

from Spain's equity$).$ To consider project feasibility,

Required:

a$1.$ Estimate the construction draw schedule, interest carry, and total loan amount for improvements.

a$2.$ Determine total project cost $($including fees$)$ less financing and the equity needed to fund improvements.

b$1.$ Estimate cash flows from operations.

b$2.$ Estimate cash flow from eventual sale.

c$.$ After discounting equity cash inflows and outflows, is the NPV positive or negative?

d$.$ If the asking price of the land were $$405,000,$ would this project be feasible?