Reference no: EM13388415

Waldo County, the well-known real estate developer, worked long hours, and he expected his staff to do the same. So 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 toward Maine. “First thing Monday will do just fine,” he said as he handed George the file. “I'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 Table 10.8. 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 real estate taxes were all likely to rise in line with inflation, which was forecasted at 2% a year. The company's tax rate was 35% 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.