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:

         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: Interest21,459,375.0021,301,941.4821,130,338.9520,943,292.1920,739,411.23
Before Tax Cash Flow16,690,625.0017,992,558.5219,342,996.0513,368,335.6114,601,565.40

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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