Based on the information below, analyze whether the development project should be undertaken, and state what is the maximum land value that could support economic development. Also compute the "canonical" OCC of investment in this development project, and compare that to the project's going-in IRR at the given land price. State clearly any assumptions you feel you must make beyond the information provided. You must clearly show your work and steps for full credit and you may ignore the potential value of waiting to invest later).
• Time zero price of the site is $1,000,000.
• Total construction cost is projected to be $3,000,000, and construction is expected to take 1 year T =1), with payment for work done owed to the contractor projected to occur in a single payment of $3,000,000 at the end of the 1-year construction phase.
• Construction completion is expected to be followed by 1 year of absorption lease-up), that can be represented by a single projected net operating cash flow at the end of year 2 of negative $200,000.
• Stabilized operation beginning at the end of Year 2 includes projected NOI = $400,000/yr with projected growth of 1% per year thereafter based on rental market projections.
• OCC going-in IRR) for investments in stabilized property projected to be 8% per annum.
• OCC for lease-up asset investments is 200 basis-points greater than the OCC for stabilized investment.
• OCC of construction cost cash flows is 3.50%.

Question

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The Answer is

\begin{array} { l } Define ~Time~ T ~= ~end~ Yr.2\V _ { T } = \frac { \$ 400,000 } { .08 - .01 } - \$ 200,000 = \frac { \$ 400,000 } { .07 } - \$ 200,000 = \$ 5,714,000 - \$ 200,000 = \$ 5,514,000 \K _ { T } = \$ 3,000,000 ( 1.035 ) = \$ 3,105,000 \\frac { V _ { T } - K _ { T } } { \left( 1 + E \left[ r _ { c } ight] ight) ^ { T } } = \frac { V _ { T } } { \left( 1 + E \left[ r _ { V } ight] ight) ^ { T } } - \frac { K _ { T } } { \left( 1 + E \left[ r _ { D } ight] ight) ^ { T } } = \frac { \$ 5,514,000 } { ( 1 + .10 ) ^ { 2 } } - \frac { \$ 3,105,000 } { ( 1 + .035 ) ^ { 2 } } \= \$ 4,557,000 - \$ 2,899,000 = \$ 1,658,000 \= \frac { - \$ 3,000,000 } { 1 + .035 } + \frac { - \$ 200,000 } { ( 1 + .10 ) ^ { 2 } } + \frac { \$ 5,714,000 } { ( 1 + .10 ) ^ { 2 } } = \$ 1,658,000 \N P V = \$ 1,658,000 - \$ 1,000,000 = + \$ 658,000 . \Y e s , ext { Invest } ( b u i l d ) . M a x ext { feasible land price } = \$ 1,658,000 . \= \frac { \$ 5,514,000 - \$ 3,105,000 } { \$ 1,658,000 } = \frac { \$ 2,409,000 } { \$ 1,658,000 } = 1.2052 ^ { 2 } \Rightarrow 20.52 \% = E \left[ r _ { c } ight] = ext { canonical } O C C \= \frac { \$ 5,514,000 - \$ 3,105,000 } { \$ 1,000,000 } = \frac { \$ 2,409,000 } { \$ 1,000,000 } = 1.5521 ^ { 2 } . \Rightarrow 55.21 \% = ext { going - in IRR }\end{array}

Part VI: Extra-credit question. Earn up to 5 points extra credit. It can help you but not hurt you.

Based on the Information Below, Analyze Whether the Development Project