Question

undblad Construction Co. recently acquired ten acres of land and is weighing two options for developing the land. The first proposal is to build ten single-family homes on the site. This project would generate a quick cash payoff as the homes are sold over the next two years. Specifically, Lundblad estimates that it would spend $2.5 million on construction costs immediately, and it would receive $1.6 million as cash inflows in each of the next two years.
The second proposal is to build a strip shopping mall. This project calls for Lundblad to retain ownership of the property and to lease space to retail businesses that would serve the neighborhood. Construction costs for the strip mall are also about $2.5 million, and the company expects to receive $350,000 annually (for each of 50 years, starting one year from now) in net cash inflows from leasing the property. Lundblad’s cost of capital is 10%.
a. Rank these projects based on their NPVs.
b. Rank these projects based on their IRRs.
c. Rank these projects based on their PIs. Do these rankings agree with those based on NPV or IRR?
d. Draw NPV profiles for these projects on the same set of axes. Use this graph to explain why the NPV and IRR methods yield mixed signals in this case.
e. Which project should Lundblad choose?
f. Which project should Lundblad choose if its cost of capital is 13.5%? 16%? 20%?


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  • CreatedMarch 26, 2015
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