Espada Real Estate Investment Company (EREIC) purchases new apartment complexes, establishes a stable group of residents, and then sells the complexes to apartment management companies. The average holding time is three years. EREIC is currently investigating two alternatives.

1. EREIC can purchase Harding Properties for $4,500,000. The complex is expected to produce net cash inflows of $360,000, $502,500, and $865,000 for the first, second, and third years of operation, respectively. The market value of the complex at the end of the third year is expected to be $5,175,000.

2. EREIC can purchase Summit Apartments for $3,450,000. The complex is expected to produce net cash inflows of $290,000, $435,000, and $600,000 for the first, second, and third years of operation, respectively. The market value of the complex at the end of the third year is expected to be $4,050,000.

EREIC has a desired rate of return of 12 percent.

Required

a. Divide the class into groups of four or five students per group and then divide the groups into two sections. Assign Task 1 to the first section and Task 2 to the second section.

Group Tasks

(1) Calculate the net present value and the present value index for Harding Properties.

(2) Calculate the net present value and the present value index for Summit Apartments.

b. Have a spokesperson from one group in the first section report the amounts calculated by the group. Make sure that all groups in the section have the same result. Repeat the process for the second section. Have the class as a whole select the investment opportunity that EREIC should accept given that the objective is to produce the higher rate of return.

c. Assume that EREIC has $4,500,000 to invest and that any funds not invested in real estate properties must be invested in a certificate of deposit earning a 5 percent return. Would this information alter the decision made in Requirement b?

d. This requirement is independent of Requirement c. Assume there is a 10 percent chance that the Harding project will be annexed by the city of Hoover, which has an outstanding school district. The annexation would likely increase net cash flows by $37,500 per year and would increase the market value at the end of year 3 by $300,000. Would this information change the decision reached in Requirement b?