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We are considering buying a parcel of land that has been zoned for multifamily housing. We have determined that the best use of this land
We are considering buying a parcel of land that has been zoned for multifamily housing. We have determined that the best use of this land is to build condominiums. Our first decision involves the scale of our investment. The size of the lot dictates that we can build three units per floor and our issue is whether to build a two- or three-story building. A two-story building would have six units and would cost $80,000 per unit to build. A three-story building would have nine units and would cost $90,000 per unit to build. Cost per unit increases as the building gets taller, largely because of additional foundation and elevator costs. We will assume that fully rented condos just break even on a cash flow basis so that they earn their entire return through expected capital gains. Our second decision involves timing. The current value of a one-unit condominium is $100,000, but the housing market is volatile. We assume that, with equal likelihood, the price of a condominium in one year will be either $150,000 or $90,000. The risk-free rate of interest is 10% and TC=0. a. What is the static NPV of the immediate development of a two-story building? Assume that the building will be built immediately and the condos sold immediately. b. What is the static NPV of the immediate development of a three-story building? Assume that the building will be built immediately and the condos sold immediately. c. If the choice between a two-story building and a three-story building were made today, which should we choose? a. Build the two-story building. b. Build the three-story building. c. It does not matter which building we choose, the two alternatives have the same NPV. d. We should not build anything on the lot, both alternatives have a negative NPV. e. We should build a gas station and a convenience store instead. d. If the choice between a two-story building and a three-story building were made today, what is the maximum amount we would be willing to pay for the parcel of land? a. $900,000 b. $810,000 c. $600,000 d. $480,000 e. $120,000 f. $90,000
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