Assignment 3 FINC6024
Total Marks: 10
1) [2.5 Marks] Case 3: Executive Summary of the Case 3 Resolution (max 200 words).
Provide an executive summary of your team's case 3 resolution. Your executive summary should focus on the macro-level reasoning and recommendations. It may help you to imagine that this ES will be the first thing (on your resolution) read by the CEO.
2) [5 Marks] Optimal Capital Structure of A-REITs & Stapled Securities
Should A-REITs be highly leveraged, or lowly leveraged? Describe the optimal capital structure for a generic Australian Real Estate Investment Trust (A-REIT). How does your answer change if the A-REIT is a stapled security? Please include discussion of target leverage, maturity, debt security and the influence of common debt covenants. (500 words max).
3) [2.5 Marks] The ABC Corporation is considering opening an office in a new market area that would allow it to increase its annual sales by $2.85 million. The cost of goods sold is estimated to be 45 percent of sales, and corporate overhead would increase by $297,000, not including the cost of either acquiring or leasing office space. The corporation will have to invest $2.3 million in office furniture, office equipment, and other up-front costs associated with opening the new office before considering the costs of owning or leasing the office space.
A small office building could be purchased for sole use by the corporation at a total price of $4.1 million, of which $700,000 of the purchase price would represent land value, and $3.4 million would represent building value. The cost of the building would be depreciated over 42 years. The corporation is in a 30 percent tax bracket. An investor is willing to purchase the same building and lease it to the corporation for $467,000 per year for a term of 15 years, with the corporation paying all real estate operating expenses (absolute net lease). Real estate operating expenses are estimated to be 48 percent of the lease payments. Estimates are that the property value will increase over the 15-year lease term for a sale price of $5.2 million at the end of the 15 years. If the property is purchased, it would be financed with an interest-only mortgage for $2,870,000 at an interest rate of 10 percent with a balloon payment due after 15 years.
a. What is the return from opening the office building under the assumption that it is leased?
b. What is the return from opening the office building under the assumption that it is owned?
c. What is the return on the incremental cash flow from owning versus leasing?
d. In general, what other factors might the firm consider before deciding whether to lease or own?