Professional Development investment

You are an investor with £12 million cash to invest. You wish to purchase an office building with this cash. You have a choice between three identical office buildings that are located in different areas of the same city. The following information is available regarding the three possible investments:

                    Building 1      Building 2      Building 3  

Distance from the CBD (km) 0 5 10
Floor space (square metres) 1,000 1,500 2,000
Asking price (GBP) 8,000,000 12,000,000 11,000,000
Management costs (GBP per square metre per month) 15 5 10

  1. Commercial rent in the central business district (CBD) is £60 per square metre per month and decreases cumulatively by 5% for each kilometre located away from the CBD.
  2. Building 2 has been certified as complying with sustainability standards.
  3. A suitable discount rate for all areas is 6%.
  4. There is a fountain outside Building 1 that you can persuade the local government to renovate by the time you purchase the property. Similar renovations to properties in the area have increased the rent charged per square metre by 3%.
  5. The local government will impose a 2% tax, by the time you complete the purchase of the property, on the sale of all properties that are not certified as compliant with sustainability standards. Ignore the effects of any other taxes.

Question 1

Calculate the net present value and internal rate of return of each building assuming that net operating income will be received in perpetuity. Round your calculated net present value to the nearest pound and your calculated internal rate of return to two decimal places.

                                        (15 marks)

Recommend, based on your calculations in Question 1.1, and purely from a financial perspective, which building to invest in.

                                        (1 mark)

Question 2

Would your answer to Question 1.2 change if you were to finance the asking price of each building with a 50% loan-to-value mortgage? The loan bears interest at a rate of 4% and can be rolled over forever.

                                        (11 marks)

Assume, once again, that the asking price of the building is financed with a 50% loan-to-value mortgage. In addition, assume that banks have different preferences for investing into buildings in different parts of the city as they want to diversify their risk portfolio. Therefore, banks are willing to offer you different loan prices for the different buildings as follows:

    Building 1:             6.65%                       
    Building 2:         5.32%                       
    Building 3:             3.92%                       

Calculate the internal rate of return and net present value of each building assuming that net operating income will be received in perpetuity. Round your calculated net present value to the nearest pound and your calculated internal rate of return to two decimal places.

                                        (4 marks)

Question 3

“In Questions 1 and 2, rent was assumed to be fixed over time. In reality, this is not the case. The growth in rent for each of the three buildings is likely to differ because, even though the buildings are the same, they are in different locations.

Assume that the level of rent that each building is currently at is fair market rent. How would you expect rent levels to change in the future? Use your understanding of urban economics to inform your answer. Please limit your answer to 300 words. ”

The following rubric will be used to grade your answer in Question 3:

        Unsatisfactory          Limited     Accomplished        Exceptional 

Adherence to the brief Answer does not address the requirements of the question. (0) Answer does address the requirements of the question, but important parts of the question are not addressed. The answer is more than 50 words over the prescribed word count. (1) Answer addresses the requirements of the question. Almost all information is provided and relevant, but there is some room for improvement. (2) Answer addresses all the requirements of the question. All information provided is comprehensive and relevant. (3)

The student chooses one of the three options provided.

The student’s answer provides justification for their choice based on urban economics theory.

The student’s answer adheres to the word limit.

Evidence of understanding and use of urban economics theory Answer bears no evidence of an understanding of the content. (0) Answer bears little evidence that the student has an understanding of the content, and the content is not applied to the context of the question. (1) Answer bears evidence that the student has an understanding of the content and has applied it to the question. (2) Answer shows that the student has an excellent understanding of the content and has skilfully applied it to the requirements of the question. (3)

The answer demonstrates that the student grasps the content.

The answer demonstrates that the student has an understanding of the fact that rents are dynamic, that they grow at a different rate, and that they change over time. Answer does not indicate why rents are dynamic, why they grow at a different rate, and why they change over time. (0) Answer provides little evidence of why rents are dynamic, why they grow at a different rate, and why they change over time. (1) Answer bears evidence of why rents are dynamic, why they grow at a different rate, and why they change over time. (2) Answer shows that the student has an excellent understanding of why rents are dynamic, why they grow at a different rate, and why they change over time. (3)

Answer includes examples of what might cause rent levels to change in future. Answer provides no examples. (0) Answer provides some examples, although they do not demonstrate that the student has thought about what might cause changes in rents in future. (1) Answer provides more than one example that illustrates how changes in the future may affect rent levels. (2) Answer provides two or more examples that illustrate how changes in the future may affect rent levels. (3)

Coherence and clarity Answer is incoherent and unclear. The answer is not logically structured or is incomprehensible. (0) Answer is somewhat coherent but lacks clarity. The answer is comprehensible but lacks logical structure. (1) Answer is written clearly and coherently. The writing is logically structured, but there remains some room for improvement. (2) Answer is extremely well structured and written with exceptional clarity and coherence. (3)

The answer is clearly structured and written in a way that is comprehensible.

Sample Solution

ACED ESSAYS