1. Consider the following projected cash flows (including reversion) for Property A and Property B for the following 10 years. Annual net cash flow projections for two properties ($ millions) 1 2 3 4 5 6 7 8 9 10 A $1.0000 $1.0050 $1.0100 $1.0151 $1.0202 $1.0253 $1.0304 $1.0355 $1.0407 $12.7252 B $1.0000 $1.0200 $1.0404 $1.0612 $1.0824 $1.1041 $1.1262 $1.1487 $1.1717 $14.7395
a. What is the annual growth rate in operating cash flows for each building during the first nine years?
b. If both properties sell at cap rates (initial and terminal cash yields) of 9%, what is the expected annual return on a 10-year investment in each property?
c. If the 9% cap rate represents a fair market value for each property, then which property is the more risky investment (and how do you know)?
2. You are considering investing in Property B in question 1. The listing price of the property is $11 million. You know that the historical annual returns on this type of property has been 10%, and the historical risk premium on this type of property has been 5.5%. In alternative investments tools, the prices of zero coupon treasury bonds are as follows: Prices of zero coupon treasury bonds (denomination = $1,000)
Maturity(yr) 1 2 3 4 5 6 7 8 9 10
Price $971 $934 $889 $839 $784 $725 $665 $604 $544 $485
How much is the property worth? Is this a good investment opportunity?