You are the group of resident economic experts of Maltana Building Enterprise, which is a commercial real estate developer. Your responsibilities are such that you as a group report directly to Susan Smith, the Vice President of External Relations and Development. Today Susan has sent your group an email asking you to work on a project that has to be completed in about a week. She has advised all members of your group to see her to discuss the project.

When you stop by Susan's office later in the day, she tells you that Maltana is thinking about leasing a piece of land where it can build a shopping center. Maltana would own and operate the shopping center, but the idea is to generate revenue by renting space to retailers. Susan would like you to do some work that would help estimate the prospect of the project. Specifically, she would like you to answer the following questions.

1. What is the optimal size of the shopping center (to the nearest 100 square meters) based on existing estimates of the demand for retail space? 2. What is the most Maltana should be willing to pay to lease the land for the expected life of the project? 3. What is the amount of profit under each possible demand curve with the optimum size of the shopping centre? 4. Is it worth hiring a local consultant, Dave Heath, to do some additional market research that would provide a better estimate of the demand for retail space? If so, then what is the maximum consulting fee that Maltana should offer to Dave?

Summarise the results of your analysis and any recommendations you would like to make.

Susan also informs you that, Mark Bernstein, a former employee of Maltana, did some baseline work on the project. Susan says that you should have complete confidence in any work Mark did on the project and that you should use his findings and assumptions as a starting point for your analysis. In fact, Susan has reviewed Mark's notes and quickly summarises the key information she thinks you'll need for your analysis.

Specifically, she tells you that:

i) Mark thought the shopping center would take one year to build and would last 20 years. He estimated that it would cost $100 per square meter to build and that the annual operations and maintenance costs would be $1 per square meter of floor space.

ii) Mark thought that the parcel of land would be large enough to build a shopping centre with as much as 60,000 square meters of retail space. He also thought that Maltana should make a one time upfront payment to lease the parcel of land for the expected 20-year life of the project.

iii) Mark thought the amount retailers in the shopping center would be willing to pay per square meter of floor space would be a decreasing function of the total size of the shopping centre. Dave did some initial work estimating the likely relationship between what tenants would be willing to pay for retail space and the size of the shopping centre. Specifically, he thought there was a 50% chance the true relationship would be:

r = 60 - 0.001s

and a 50% chance that the true relationship would be:

r = 50 - 0.001s

where r is the yearly rental rate per square meter of floor space and s is the total size of the shopping centre in square meters. Furthermore, Mark predicted that once the shopping centre had been built, the realized relationship between r and s would remain unchanged for the next 20 years.

Susan also advises to ignore discount rates and the time value of money in your initial evaluation of the project. That means you are going to treat all of the project's costs and benefits equally no matter when they occurred in the life of the project; that is, you will have to treat a $1 cost incurred (or revenue received) at the start of the project the same as a $1 cost incurred (or revenue received) during any other year of the project's life. At this point, you tell Susan that doing this could lead to misleading conclusions about the real value of the project and how much Maltana should be willing to pay to lease the land. Susan agrees, but says she thinks this approach is good enough for a preliminary evaluation. (HINT: Do not try to account for the time value of money in your analysis. Simply treat all costs incurred [or revenues received] as equivalent no matter when they occur. Doing so means you can calculate the total costs over the life of the project by simply summing the costs incurred in each year. Similarly, you can calculate the total revenues received over the life of the project by simply summing the revenues received in each year.)

Susan has contacted a local consultant, Dave Heath, who could do some additional market research to accurately forecast which of the demand curves (i.e., r = 60 - 0.001s or r = 50 - 0.001s) would actually be realised if the shopping centre was built. Susan is trying to find out if it is worth hiring Dave at all, and if he is hired then what is the maximum consulting fee that Maltana should offer. (HINT: In the first scenario, if Maltana were to hire Dave, Maltana would build a shopping centre that is sized optimally for the demand curve that Dave identifies in his report. For example, if Dave's report says that the demand curve will be r = 60 - 0.001s then Maltana will build a shopping center that is optimally sized for that demand curve. Similarly, if Dave's report says that the demand curve will be r = 50 - 0.001s, then Maltana will build a shopping centre that is optimally sized for that demand curve. Nonetheless, a decision to hire Dave does not affect the fact that there is still a 50% chance that the demand will actually turn out to be

r = 60 - 0.001s

and a 50% chance that the demand curve will actually turn out to be

r = 50 - 0.001s)

[Additional Hint: As we know, if the Total Revenue function is of the form, TR = as - bs2, where a and b are positive constants, then the Marginal Revenue function is of the form, MR = a - 2bs]

Susan also makes it clear that Maltana Building Enterprise should be considered as risk-neutral.