A company has the opportunity to take over a redevelopment project in an industr

Question

A company has the opportunity to take over a redevelopment project in an industrial area of a city. No immediate investment is required, but it must raze the existing buildings over a four year period and, at the end of the fourth year invest $2,400,000 for new construction. It will collect all revenues and pay all costsfor a period of 10 years, at which time the entire project and properties thereon will revert to the city. The net cash flows are estimated to be as follows:

Year End Net Cash Flow 1 $500k 2 $300k 3 $100k 4 -$2.4M 5 $150k 6 $200k 7 $250k 8 $300k 9 $350k 10 $400k

Explanation / Answer

IRR Method

PW(i’%) = 0 = 500,000(P/F, i’ % l) + 300,000(P/F i’%, 2)

+ [100,000 + 100,000(P/A, i’%, 7) + 50,000(P/G, i’%, 7)](P/F, i’%, 3) - 2,500,000 (P/F, i’%, 4)

i(%) Present Worth         i(%) Present Worth

1 103,331.55                  30 -12,186.78

2 63,694.68                      31 -5,479.09

3 30,228.14                      32 1,182.76

4 2,175.18

5 -21,130.28

There are two internal rates of return: 4.9% and 31.2%:

ERR Method

2,400,000 (P/F,8%,4)(F/P,i’%,10) = 500,000(F/P,8%,9) +300,000(F/P,8%,8)

+ 100,000(F/P,8%,7) + 150,000(P/A,8%,6)(F/P,8%,6) + 550,000(P/G,8%,6)(F/P,8%,6)

7.6%

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