Question

In: Accounting

A joint venture formed by South-East Investment Company (SEI) and North-West Property Limited (NWP) is going...

A joint venture formed by South-East Investment Company (SEI) and North-West Property Limited (NWP) is going to bid for a site that could be developed into an office building, providing a rentable area of 70,000 square foot. SEI will contribute 90% of the equity capital and NWP the remaining 10%. According to some estimates, it is believed that the chance to receive average rents of $100 per square foot is 60% and the chance to receive $60 per square foot is 40%, in the first year after construction. Assume operating expenses are always equal to 40 percent of the rent received. The joint venture expects the rent will grow at 3 percent indefinitely and it requires a 12 percent return on the investment. The office building would cost $500 per square foot to build, and it takes a year’s time to finish the construction.

(a) Find the expected net operating income (NOI) from the office building and also the capitalization rate.

(b) Base on the Traditional Approach, what are the expected value of the office building and the land value under the above assumptions?

(c) Suppose that the land price asked by the government is $3,000,000. Base on your answer in part (b), would the joint venture’s office project be feasible?

(d) Discuss one advantage of forming a joint venture.

(e) Find the land value again by using the Real Option Approach.

(f) Discuss and explain two factors that may increase NOI.

Solutions

Expert Solution

As per our guidelines, Answered 4 questions. Please post the question e and f seperately. Thanks.

Solution A
Calculation of Net Operating Income
Formula Working Result
Expected Income = Income * Probability (100*0.6+60*0.4)*70000 square foot $ 5,880,000
Operation Cost = Expected Income *40% $ 5880000*40% $ 2,352,000
Net Operating Income 5880000-2352000 $ 3,528,000
Capitalised rate= Required rate of return 12%
Solution B
Expected value of office building and land value is the present value of expected cash flow generated by it
Thus value is
Net operating Income / Capitalization rate -Growth rate
$ 3528000/0.12-0.03
$ 39200000
Solution C
Cost of Land = $ 3000000
Cost of Construction of Building = $ 500 *70000
$ 35000000
Total cost of project = $ 3000000+35000000=$ 38000000
Total Project value is $ 39200000
Since the value of Project is greater than the cost of Project, hence office project is feasible
Solution D
One of the most important joint venture advantages is that it can help your business grow faster, increase productivity and generate greater profits by accessing to new knowledge and expertise, including specialised staff

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