# Sum of the parts valuation: Digital Realty Trust Harvard Case Solution & Analysis

## Sum of the parts valuation: Digital Realty Trust Case Solution

Projected income statement:

The company is expecting to increase its revenue in next three years by the percentage of 77.83%, which means that the company is expecting more rental revenue that would ultimately lead to increase in gross profit, as total expenses are increasing by 41.71% that is less than the increase in revenue.

The net income is showing favorable return in next three years, and it gives the idea of further expanding the business. The income statement shows that the interest income is increasing at 0.61%, and interest expense increased at the average of 50%. The cost of debt is 14.085%, and the company has converted its preferred shares in common shareholding and therefore, it has reduced the cost of debt as a discount rate in a new lease agreement. This resulted in decreased discount rate of 10.23% in a new lease as compared to 10.75% in existing lease.

Historical cash flows:

Since Farney wanted to determine the reasonable discount rates after separating existing lease and a new lease; thus, for this purpose, it is important to observe the historical cash flows and projected cash flows.The main components in cash flows of al Realty Trusts are earning from operations, CAPEX, change in working capital, etc.

The historical cash flows (as the existing lease), which shows total cash flow generated is \$ 0.62 million, \$ 0.64 million, and \$ 0.97 million in respective years between 2010 until 2012. The appropriate discount rate is used as 10.75% in historical cash flows in order to calculate the net fair value of company's cash flows. Therefore, it resulted in the net present value of \$ 12.923 million.

Projected Cash flows:

The projected cash flow is calculated from projected income statements and balance sheet. Cash flows are projected as \$ 1.6 million, \$ 1.64 million, and \$ 1.7 million in next three years; these years include 2013, 2014, and 2015. The discount rate in the new lease is 10.23%, and it is reduced from existing lease. Along with this, it is observed that as the projected years would increase, more cash flow would be generated in coming years, and it would further reduce the discount rate. The new lease is generating the value of \$ 26.06 million.

Therefore, it is concluded that after segregating the existing lease and new lease, the result shows that the new lease is generating high value at the low discount rate, which is \$ 26 million at 10.23%. On the other hand, the existing lease is generating lower net value and at some higher discount rates, which is \$ 12.93 million at 10.75% discount rate. The reason behind decreasing the discount rate is the conversion of preferred shares into common shares that decreases the cumulative rate of a discount rate.

Specific components to be valued

After analyzing the specific components for the real estate valuation, it has been determined that each component would increase its square feet value as well as annualized rental per year at the fixed determined percent. According to the solution, it is identified that Turnkey lease would tend to increase by 5.20% per year due to the element of inflation involved within a cost of operations. The annualized rental would tend to increase at the same rate because of the heavy operational activities involved under the lease of the particular component...............

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