The investor-developer would not be comfortable with a 7.8 percent return on cost because the margin for error is too risky. If construction costs are higher or rents are lower than anticipated, the project may not be feasible. The asking price of the project is $4,600,000 and the construction cost per unit is $80,400. The current rent to justify the land acqusition is $1.3 per square foot. The weighted average is 900 square feet per unit. Average vacancy and Operating expenses are 5% and 35% of Gross Revenue respectively. Based on the fact that the project appears to have 9,360 square feet of surface area in excess of zoning requirements, the developer could make an argument to the planning department for an additional 10 units, 250 units in total, or 25 units per acre. What is the percentage return on total cost under the revised proposal? Is the revised proposal financially feasible? What is the Return on total cost under the revised proposal? Additional information below: Physical Feasibility: Goal: To provide a preliminary development plan analysis to determine whether an apartment project can be built on a specific site
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
The investor-developer would not be comfortable with a 7.8 percent return on cost because the margin for error is too risky. If construction costs are higher or rents are lower than anticipated, the project may not be feasible. The asking price of the project is $4,600,000 and the construction cost per unit is $80,400. The current rent to justify the land acqusition is $1.3 per square foot. The weighted average is 900 square feet per unit. Average vacancy and Operating expenses are 5% and 35% of Gross Revenue respectively.
Based on the fact that the project appears to have 9,360 square feet of surface area in excess of zoning requirements, the developer could make an argument to the planning department for an additional 10 units, 250 units in total, or 25 units per acre. What is the percentage return on total cost under the revised proposal? Is the revised proposal financially feasible?
What is the Return on total cost under the revised proposal?
Additional information below:
Physical Feasibility:
- Goal: To provide a preliminary development plan analysis to determine whether an apartment project can be built on a specific site in accordance with regulatory requirements and leased at current rental rates in order to justify land acquisition.
- Site: 10 acres or 435,600 square feet.
- Asking price: $2,800,000.
- Basic project description/zoning:
- Setback requirements: 15%
- Circulation requirements: 15%
- Maximum units per acre: 24 (based on a unit mix of 1-, 2-, and 3-bedroom apartments; weighted average = 900 square feet per unit)
- Parking requirements: 1.5 spaces per unit @ 400 square feet per space
- Open space, berms, landscape, support area: 1.0 acre (required) based on 240 units
- Maximum building height: 2 stories
- Physical feasibility (in square feet):
| a. Gross land area | 435,600 |
|---|---|
| Less: Setbacks | 65,340 |
| Circulation | 65,340 |
| Open space/support/other | 43,560 |
| b. Area available for building development: | 261,360 |
| Less: Surface parking, 240 units × 1.5 spaces × 400 square feet | 144,000 |
| c. Net surface area available for building | 117,360 |
| d. Proposed total footprint areas for buildings, (240 units × 900 square feet) ÷ 2 stories | 108,000 |
| Excess (or deficiency) of square footage versus zoning requirements: | 9,360 |
Conclusion: It appears that the site can accommodate a 240-unit apartment project and comply with zoning requirements.
II. Financial Feasibility:
| 1. Construction cost per unit: $80,000 × 240 units | $ 19,200,000 |
|---|---|
| 2. Asking price for land: | 2,800,000 |
| Total project cost: | $ 22,000,000* |
| 3. Gross revenue after lease-up and stabilization: | |
| Rent: $1.10 per square foot @ 900 square feet @ 240 units × 12 months | $ 2,851,200 |
| Less: | |
| Average vacancy (5%) | 142,560 |
| Operating expenses (35%) | 997,920 |
| Net operating income | $ 1,710,720 |
| 4. Return on total cost ($1,710,720 ÷ $22,000,000) | 7.78% |
| 5. Approximate value based on NOI: | |
| a. If cap rate = .078 | $ 22,000,000 |
| b. If cap rate = .08 | $ 21,384,000 |
| c. If cap rate = .07 | $ 24,439,000 |
III. Conclusion: Project may be feasible if the investor/developer is willing to accept a total return on cost of 7.8%. If, upon completion, investors are pricing comparable projects at a cap rate of .08, this proposed project would not be feasible because value ($21,384,000) is less than cost ($22,000,000). If projects are being priced at cap rates of .07, the project would produce a sizable development profit of $2,439,000 (or $24,439,000 − $22,000,000).
*Includes all infrastructure (roads, drainage, utilities, sewer costs), land, and building costs.
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