Reference no: EM131735666

Problem: The Rentleg Distribution Center is a warehouse complex near the Cincinnati Airport in Northern Kentucky, in a market where such buildings currently sell at 10% cap rates (net cash flow/property value), with 1.0% expected long-run average annual growth (in both value and cash flow). This property has initial net cash flow of $2,500,000 per year. Both the Grump REIT and BSR (from Questions 1 and 2) are considering bidding to buy the Rentleg Center.

a. Ignoring possible differential valuation between the stock and property markets, what is the (marginal) opportunity cost of capital for acquisition of the Rentleg Center by either REIT (i.e., what is the discount rate relevant for a DCF valuation of the Rentleg Center on the part of either one of the two REITs)?

b. What is the maximum price Grump can offer for the Rentleg Center without its share price being diluted?

c. What is the maximum price BSR can offer for the Rentleg Center without its share price being diluted? d. If BSR is able to purchase the Rentleg Center for $24,000,000, what will be the change in the (aggregate) value of BSR's equity as a result of this transaction (assuming the stock market had not already factored such an expected purchase into its valuation of BSR's shares)?

Questions 1: The Donald Grump Corporation, a publicly traded REIT, has expected total return to equity of 13%, average interest rate on its debt of 7.5%, and a debt/total asset value ratio of 40%.

a. What is Grump's equity average cost of capital?

b. What is Grump's firm-level overall average cost of capital?

Questions 2: Bob & Sue Realty (BSR) is a publicly traded REIT that has no debt and a current dividend yield of 8%, with a current share price/earnings multiple of 12.5. The current consensus expectation among stock analysts who follow BSR is that BSR can provide a long-term average growth rate in its dividends per share of 5% per year.

a. What is BSR's plowback ratio (i.e., what proportion of its earnings does it retain and not pay as dividends)?

b. Assuming the stock market agrees with these analysts expectations, what is BSR's firm level average cost of capital?