Question
Siljan Properties, a Swedish income property investor, is considering the acquisition of an office building in Warsaw (Poland). The property has a construction area of
Siljan Properties, a Swedish income property investor, is considering the acquisition of an office building in Warsaw (Poland). The property has a construction area of 13.200 sqm built over street level (ground level plus 8 floors) and 3.000 sqm of parking space below street level (2 floors). A shop will be established in the ground floor.
Important rehabilitation work must be done during the first 2 years after the purchase. Therefore, the building will only be occupied after rehabilitation work is concluded (starting in year 3). It is estimated that future rehabilitation work will be required every 50 years starting in year 50. However, major maintenance will be necessary starting in year 11 and every 10 years afterwards.
The offered price is 1.500 /sqm of construction area above street level for a total purchasing price of 19.800.000. A 20% down-payment is required and the balance will be paid in two installments in years 1 and 2. To help finance the acquisition Siljan will issue a bond for 10 million at the end of year 1 to be paid in full at the end of year 11. The coupon will be 7% yearly. Please, refer to Exhibit A for other details of the proposal.
You have been hired to do a discounted cash flow valuation of this investment. The valuation will be performed in two parts: first the unlevered property will be valued, and second the impact of the bond issue will be considered to obtain the value of the levered property. All computations must be performed in nominal terms.
You must work with the following assumptions:
- There are no property taxes.
- Purchase taxes will be paid out together and proportionally with the purchase installments. Other purchase expenses will be paid in cash at time of purchase.
- Purchase expenses are tax deductible but purchase taxes are not.
- Ignore tax carry-forward. That is, if in any year earnings are negative assume a positive tax cash flow.
- For simplicity the same vacancy rate must be applied to the three categories (offices, shop and parking). It is true that one partially occupied shop is not realistic, but this assumption will not make a material difference in the final result.
- The percentage of expenses to be recovered only applies to existing tenants, so this percentage is actually not fully recovered. Recoveries will be considered a risk-free cash flow.
- The first integral rehabilitation must be depreciated over 48 years (once completed).
- Maintenance costs, expenses and rents are given at year 1 prices, and rehabilitation costs are given at year 0 prices. Future values must be adjusted for inflation.
- The valuation demands the separation of the cash flow streams into four categories: office, shop, parking and risk-free cash flows. When the time comes to discriminate among cash flow categories, all income taxes must be allocated in proportion to the gross potential income of each category (no income taxes must be included in the risk-free cash flow).
- For simplicity the depreciation tax shield during the projection period is not treated as a separate risk-free cash flow. Instead depreciation is incorporated in the risky cash flows.
- Regarding the perpetuities:
- Assume that Gross Adjusted Income grows at the inflation rate starting in year 11. There will be only one adjusted gross income perpetuity that will include the three income categories (office, shop and parking). Estimate the corresponding yield as a weighted average of the yields of each category in proportion to their respective gross potential incomes. Remember to discount the second term (depreciation tax shield) of the adjusted gross income perpetuity at the risk-free rate all the way back to t=0.
- Consider that both integral rehabilitation and major maintenance will be completed in one year.
- The bond issue is contingent on the purchase of the property. Disregard any implications of the bond issue on the firms capital structure or its cost.
2) DELIVERABLES
The case must be solved in five parts to be graded separately. At completion of each part the students will be given the right solution and all subsequent parts must be worked out with the provided solutions. A description of each part with its corresponding weight in the case grade follows:
Calculate the present values at time t = 11 of each of the perpetuitys components (gross adjusted income, risk-free, maintenance and rehabilitation) (30%).
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Design Of Cost Management Systems The Text Cases And Readings
Authors: Robin Cooper
1st Edition
0132041243, 978-0132041249
