# Conundrum Office Towers Harvard Case Solution & Analysis

## Conundrum Office Towers Case Solution

1.     What is the Net Operating Income of Conundrum Office Towers from Year 1 to Year 5?

In order to calculate the net operating income of the towers, all the revenues that are generated from rentals of 10,000 square meters in Sandton Central at the rate of R4, 500 per annum are calculated. In addition to this, the revenues generated from the usage of parking area available in the tower, as well as the revenues generated from advertising are added. In order to arrive at the value of effective gross revenues, the value of vacancy credit is subtracted from the potential gross income.

From the value of potential gross revenues, all the operational expenses are subtracted in order to get the value of Net Operating Income. By using the assumption for income as well as expense growth in the subsequent years, which is 3%. In this case, future projections are made for the year 1 to year 5. Management fee is the only expense that is not subjected to an annual increment for the reason that it is calculated on the basis of potential gross revenue.

Property Value in the given case is calculated as follows:

Property Value = Net Operating Income / Capitalization Rate

It can be seen that in the given case, the net operating income is calculated to be 38,150,000 and with the capitalization rate of 8%, the property value is calculated to be 476,875,000 that is calculated by using values of year 2016. The value of before tax cash flow is also calculated by subtracting the amount of interest from the net operating income. Overall calculation is summarized in the table shown below:

 2016 2017 2018 2019 2020 Year  1 Year  2 Year  3 Year  4 Year  5 Potential Gross Revenue 45,000,000 46,350,000 47,740,500 49,172,715 50,647,896 Vacancy Allowance (4,500,000) (4,635,000) (4,774,050) (12,293,179) (12,661,974) Scheduled Base Rental Revenue 40,500,000 41,715,000 42,966,450 36,879,536 37,985,922 Net Parking Income 300,000 309,000 318,270 327,818 337,653 Advertising Income 150,000 154,500 159,135 163,909 168,826 Effective Gross Revenue 40,950,000 42,178,500 43,443,855 37,371,263 38,492,401 Operating Expenses (OEX) Utilities 300,000 309,000 318,270 327,818 337,653 Advertising Expense 50,000 51,500 53,045 54,636 56,275 Repairs & Maintenance 100,000 103,000 106,090 109,273 112,551 Management Fees 2,250,000 2,317,500 2,387,025 2,458,636 2,532,395 Insurance 100,000 103,000 106,090 109,273 112,551 Total Operating Expenses 2,800,000 2,884,000 2,970,520 3,059,636 3,151,425 Net Operating Income (NOI) 38,150,000 39,294,500 40,473,335 34,311,628 35,340,977 Less: Interest 21,459,375.00 21,301,941.48 21,130,338.95 20,943,292.19 20,739,411.23 Before Tax Cash Flow 16,690,625.00 17,992,558.52 19,342,996.05 13,368,335.61 14,601,565.40

2.     What is the initial debt payment structure from ADF bank from Year 1 to Year 5?

In order to calculate the debt payment structure using the initial financing option, as proposed by ADF Bank to the young real estate fund manager. The real estate fund manager owns Conundrum Office Tower, which includes the fully amortized loan of 30 years at the interest rate of 9%, the overall calculation is summarized in the below given table.

The loan to value ratio as suggested was 50%, which is quite a typical financing structure that could lead the owner to go bankrupt. The company should arrange some other source of financing for sustainability. In addition to this, the owner should engage in some kind of hedging alternatives in order to meet the challenges of repayment of the overall loan...................

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