Waldo County, the well-known real estate developer, worked long hours, and he expected his staff to do the same. Therefore, George Chavez was not surprised to receive a call from the boss just as George was about to leave for a long summer's weekend.

Mr. County's success had been built on a remarkable instinct for a good site. He would exclaim "Location!

Location! Location!" at some point in every planning meeting. Yet finance was not his strong suit. On this occasion, he wanted George to go over the figures for a new $90 million outlet mall designed to intercept tourists heading downeast from Bar Harbor through southern Maine.

"First thing Monday will do just fine," he said as he handed George the file. "T'll be in my house in Bar Harbor if you need me."

George's first task was to draw up a summary of the projected revenues and costs. The results are shown in the following Table. Note that the mall's revenues would come from two sources: The company would charge retailers an annual rent for the space they occupied and, in addition, it would receive 5% of each store's gross sales.

Construction of the mall was likely to take three years. The construction costs could be depreciated straight-line over 15 years starting in year 3. As in the case of the company's other developments, the mall would be built to the highest specifications and would not need to be rebuilt until year 17. The land was expected to retain its value, but could not be depreciated for tax purposes.

Construction costs, revenues, operating and maintenance costs, and local real estate taxes were all likely to rise in line with inflation, which was forecasted at 2% a year. Local real estate taxes are deductible for corporate tax. The company's corporate tax rate was 25% and the cost of capital was 9% in nominal terms.

George decided first to check that the project made financial sense. He then proposed to look at some of the things that might go wrong. His boss certainly had a nose for a good retail project, but he was not infallible. The Salome project had been a disaster because store sales had turned out to be 40% below forecast. What if that happened here? George wondered just how far sales could fall short of forecast before the project would be underwater.

Inflation was another source of uncertainty. Some people were talking about a zero long-term inflation rate, but George also wondered what would happen if inflation jumped to, say, 10%.

A third concern was possible construction cost overruns and delays due to required zoning changes and environmental approvals. George had seen cases of 25% construction cost overruns and delays up to 12 months between purchase of the land and the start of construction. He decided that he should examine the effect that this would have on the project's profitability. But he realized that building a spreadsheet and running scenarios was not enough. He had to figure out how to summarize and present his results to Mr.

County.

Year

Investment

Land

Construction

30 20

Operations:

Rentals

Share of retail sales

Operating and maintenance costs

Local real estare taxes.

?

1

30

2

10

43

4

5-17

12 24

10

4

24

10

QUESTIONS

1. What is the project's NPV, given the projections in the above Table?
2. Conduct a sensitivity and a scenario analysis of the project. (Take all the necessary assumptions you need). What do these analyses reveal about the project's risks and potential value?

Page 2 of 3

Case 2: (50 points)

The New Economy Transport Company (NETCO) was formed in 1959 to carry cargo