Question 1. Capital budgeting (40 points) Please use an excel workbook to lay out the capital budgeting problem and illustrate the estimation process for cash flows, and write down the solutions and discussions in this word document. Please remember to turn in the excel workbook along with your final word document. 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. "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 1. 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 18. The land was expected to retain its value, but could not be depreciated for tax purposes. The company's tax rate was 35% and the cost of capital was 9%. Table 1. Projected revenues and costs in real terms for the Downeast Tourist Mall (figures in millions). QUESTIONS 1. What is the project's NPV, given the projections in Table 1 ? (15 points) 2 Conduct a sensitivity and a scenario analysis of the project. What do these analyses reveal about the project's risks and potential value? a. The Salome project had been a disaster because store sales had turned out to be 40% below forecast. What if that happened here? (5 points) b. George also wondered how far sales could fall short of forecast before the project would be underwater (meaning NPV less than 0) ? (12 points) c. Another concern was possible construction cost overnuns 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. (8 points)
