[Mwcc]

You are CFO of ABC Construction and Leasing Company. ABC Construction and Leasing Company are interested in investing in the residential real estate market due to a relatively low interest rate environment. The Company appointed you to be in charge of the project feasibility study. You have just visited a 35-year old, well-managed residential apartment building in a Toronto downtown area which is for sale. The apartment is fully occupied with 400 tenants, and the current average renter pays $2,000 per month. However you are not sure whether this investment will provide you with adequate returns for the risk you are taking. Please perform analysis using everything you learned from Corporate Finance.

If you acquire the building, you consider the alteration of each suite’s layout to provide more generous living space and a better balance of living and bedroom accommodation. If you renovate the place, a monthly average rental income of $2,500 per month is expected. The estimated renovation cost is $10,000,000. If you renovate the place, you expect to fully occupy the building with the lease term of 5 years. You need to do some analysis whether it makes economic sense to spend additional capital for the renovation. You would like to sell the apartment after 5 years. If you do not renovate the apartment, then the rental agreement you would get from renters would be typically one year and thus, are expose to vacancy risk when the term is expired annually. The purchase price is expected to be $90 million before the renovation. You haven’t decided how to raise the necessary capital to purchase the property, but what you are clearly is that you cannot issue more than 30% of the acquisition cost with common stock due to potential dilution effects thus, you need to rely on external debt funding for the remainder. The Company’s equity cost is 13%, and its cost of debt is Prime rate plus 2%.

[Curlyben]

What do YOU think ?
While we're happy to HELP we won't do all the work for you.
Show us what you have done and where you are having problems..

[Mwcc]

I believe the cost of capital is (.13*.3)+(.05*.7)=.074 or 7.4%

since the yearly rent is 9.6 million and this is a perpetuity I can figure the Present value to be 9.6/.074= 128 mil so the purchase seems to make sense.

I believe the net profit value is 48 mil just the 9.6*5=48mil. As I am assuming that we will sell the property for 90milllion.

I am not sure how to calculate the Internal rate of return but believe it to be about 11%

Even though the risks are high if we do not renovate that we may not hold full tenants I believe that if the yearly rent fell to 6.66 million we would still break even as the
PV = 6.6mil/.074=90million

Am I on the right track?

if we renovate I only see a NPV of 60 million which is only 12 million more than without renovations. This would only see a profit of 2 million.