When preparing capital budgeting analysis for a new commercial real estate development, Marcus Butterman, a chief financial officer at WFB Industries, faced a dilemma. He knew his firm had flexibility as to when to undertake the development. It could be done immediately, in 2020. If so, the construction costs would be pretty high due to high demand for construction equipment from other firms. In total, he estimated the complex would cost $3M to build. However, due to significant demand for office space in Northern Milwaukee suburbs, there would be a 75% chance that the building would be rented out starting next year. If so, he expected net cash flow of 380K per year over the next 30 years. There is a 25% chance that the building would not be rented out next year, however, and the firm would need to maintain it at a cost of $50K per year.

If the building has not been rented out in 2021, there is a 65% chance it will be rented out the year after that, for net cash flow of 350K per year over the 30 years after that. If not, the cost to maintain for a year is 50K.

If the building has not been rented out in 2022, there is a 40% chance it will be rented out the year after that, in 2023, for net cash flow of 300K per year over the 30 years after that. If not, the cost to maintain for a year is 50K. If the building has not been rented out in 2023, Marcus estimates that the company will have to sell it, at around half the construction cost, or 1.5M.

Mr. Butterman is bewildered with the analysis and asks your help in determining the course of action regarding this opportunity. Mr. Butterman has estimated that the WACC for the company in certain times has been 10%. Assume that the project has no tax implications, i.e. the tax rate of 0%.

1. a) What is the NPV of building in 2020? __________________

2. b) Should the firm invest in the project in 2020, or not invest at all? __________________

3. c) If a prospective tenant agree to sign the contract for the next 30 years before the building is built, but asks for a 21% discount relative to the regular rent, which would result in net cash flow of 300K per year for the next 30 years, should WFB Industries sign this contract instead? What would the NPV be then?