Question 3

Calculate the expected return (IRR) to drive for each option. Ignore Drive’s partnership and assume that the initial cost of the distressed note was incurred entirely by Drive, that it was paid today, and that Drive will receive all future cash flows. Clearly state any other assumptions. What is the current value of Northwinds Community Crossing? Should Drive rely on the valuation provided by CB Richard Ellis? What assumptions would you make in doing your own valuation? Which assumptions are most relevant to the future value of the property?

The expected return for each of the three options has been computed in the excel spreadsheet which is shown in the table below. For the third option, if Schey takes the offer by Burton then Schey can negotiate a lower rate of interest with Burton. We have assumed this rate to be 3.5%.

Option 1: Foreclosure
Initial Cost of Distressed Note 465000    
  May-09 May-10 May-11
Year 0 1 2
Initial Cost of Distressed Note -465000    
Legal and Administrative costs of Foreclosure     50000
Rent Received (Total) 129,021 129,021
Accrued Interest   60138.16 60138.16
Less Property Taxes   31500.44 31500.44
Total Payoff at Maturity     1300441.72
Net Payoff -465000 37,382 1,287,824
Expected Return (IRR) 70%    
Option 2: Receivership
Initial Cost of Distressed Note 465000    
  May-09 May-10 May-11
Year 0 1 2
Initial Cost of Distressed Note -465000    
Rent Received (Total) 129,021 129,021
Accrued Interest   60138.16 60138.16
Less Property Taxes   31500.44 31500.44
Total Payoff at Maturity     1300441.72
Net Payoff -465000 37,382 1,337,824
Expected Return (IRR) 74%    
Option 3: Discounted Payoff
Initial Cost of Distressed Note 465000    
  May-09 May-10 May-11
Year 0 1 2
Initial Cost of Distressed Note -465000    
Rent Received (Total) 129,021 129,021
Accrued Interest (Lower Interest rate of 3.5%)   43750 43750
Less Property Taxes   31500.44 31500.44
Total Payoff at Maturity     300441.72
Net Payoff -465000 53,771 354,212
Expected Return (IRR) -7%    

Options 1 and 2 would have the IRRs of 70% and 74%, while option 3 has a negative IRR of 7%. Furthermore, we have calculated the Northwinds Community Crossing as shown below:

NORTHWINDS COMMUNITY CROSSING VALUATION
Year 2010 2011 2012 2013 2014
Mercado Real De La Villa 33,884 50,824 50,824 50,824 50,824
A&Y Metals 13,817 20,725 20,725 20,725 20,725
Gerry’s Cake Supplies 13,355 20,031 20,031 20,031 20,031
Tortas Gigantes 12,137 18,205 18,205 18,205 18,205
Osvelia’s Briada 12,825 19,236 19,236 19,236 19,236
Total Rental Income 86,018 129,021 129,021 129,021 129,021
Less: Property Taxes 31500 15028.3 15028.3 15028.3 15028.28
Net Operating Income 54,518 113,993 113,993 113,993 113,993
Cap Rate (Taken from CoStar) 9%        
Sale Value         1139927.20
Net Income 54,518 113,993 113,993 113,993 1,253,920
Property Value $1,129,702.71        

All the expenses of the property are paid by the tenants except the property taxes which we have included in the above valuation. Since, Burton had allowed the tenants to pay lower rents, therefore, we have taken the current received rent per operator and assumed that it would remain same for the next 4 years. Time apportionment has been made for rental income for the period of less than 1 year………….

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