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Discounted cash flow problem

A 100-acre tract of land within an urban municipality is scheduled to be subdivided into 320 home sites, averaging 80 feet road frontage. There is active demand for homes in the $120,000 to $140,000 price bracket. The average price of dwellings planned for the subject tract is $125,000. The ratio of site to property value in similar subdivisions is 1 to 5 ($1 land to $4 building investment).

The proposed subdivision is to be improved with all required county utilities, including 60-foot wide paved roads fitted with concrete curbs and gutters, storm water drainage, water, and sewerage systems. Telephone and electric service, including streetlights, are to be supplied through underground cables laid in heavy-gauge PVC conduits.

Analysis of development plans indicates total development costs per lot are:

Development costs $8,500
Underground electric utility lines 1,200
Engineering 800
Development fee 4,076
Interest, taxes, legal fees 500

Sales commission (10%)
Average first year lot price $26,000
Annual rate of increase in lot prices 6%
Expected yield to developer 12%

Lot sales are forecast to be 60 lots per year for years 1-5 and 20 lots in year 6.

The following information should also be considered:

Water and sewer distribution connections are estimated at $400 per lot. The developer is to receive a refund of $200 under county regulations at the time each lot is connected into the municipal system and becomes activated by customer use.

No extra cost for telephone lines or site connection is chargeable to the developer.

Advertising and field overhead costs are estimated at 3.0 percent of gross sales.

Based on market analysis and the information presented herein, derive the value of the undeveloped tract under alternative options as follows:

1. The development for the entire 320-lot subdivision is to be completed and all utilities installed during the first year. What price could an investor afford to pay for this land on the development program described previously?

2. Suppose that the developer chose to spread out his costs equally per year over 3 years. What effect would this have on the present value of the property?

3. Explain which development program you would advise the developer to select.

The development costs, electric utility lines, development fee, engineering and water/sewer distribution costs are allocated as set forth in the above two options. However, interest, taxes, legal fees, sales commission, advertising and field overhead costs, and water and sewer connection fee rebates are computed as sales occur.

Solution Preview

I've attached an Excel file with your solution. Let me explain each item.

The number of lots sold each year should be self-explanatory.

Lot price starts at $26,000 and increases 6% per year

Revenue is simply (Lots Sold)*(Lot price)

Regarding costs, I separated them in "type I" and "type II". Type I costs are the costs that, according to the problem, "are allocated as set forth in the two options". Type II costs are the ones that are computed as sales occur.

Notice that after the "Costs - Type I" table, I included a "Total Lots" row. This row is just to tell Excel if it should put all these costs in the 1st year (so it's 320 lots times the cost per lot, in ...

Solution Summary

Explain which development program you would advise the developer to select.