Your firm owns a lot in center city Philadelphia. The purchase price of the lot in 2002 was $350,000 and today its market value is 1.2 million

Your job is to determine which of the following two options would add the most value to the firm.

OPTION 1:

Build an office high rise with 450,000 square feet of office space. The street level will be dedicated to retail.

Expected revenues per square foot of office space is $22

Retail space is expected to rent for $180,000 a year.

The cost of the building is $85 million, it will be depreciated over 39 years (ignore the 1/2 year rule) and will be financed by borrowing $40,000,000 and paying the balance with cash. The cost of debt is 6% and the cost of cash 8%. (The cost of cash is the forgone return from investment). The firm tax rate is 30%

OPTION 2:

Lease the land to the developer in exchange for the use of 120,000 square feet of office space

The annual expenses for this option is $10,000 a year

Evaluate the two options over a useful life of 10 years.

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1. Calculate the initial cost outlay of option 1

a) 12,000,000

b) 86,200,000

c) 85,000,000

2. Calculate the initial cost outlay for option 2

a) 350,000

b) 1,200,000

c) 85,000,000

3. Calculate the Weighted Cost of Capital (WACC)

a) 6%

b) 6.2%

c) 8%

4. Calculate the annual revenue expected for option 1

a) 180,000

b) 9,900,000

c) 10,080,000

5. Calculate the annual benefit expected for option 2

a) 264,000

b) 300,000

c) 2,640,000

6. Calculate the annual depreciation expense for option 1

a) 2,179,487

b) 8,500,000

c) 10,000,000

7. Calculate the annual depreciation expense for option 2

a) 0

b) 120,000

c) 135,000

8. Calculate the salvage value you would take into consideration for option 1 in year 10

a) 2,179,487

b) 42,500,000

c) 64,405,128