1.Did the purchase of the Lexington Club real estate increase the value of Heatlh Development Corporation (HDC)? Calculate the NPV of the purchase. •Use pre-tax cashflows.
•Assume the revenues of the Lexington Club grow by 5% per year. •Assume that the appropriate discount rate for real estate cashflows was 10%. •Assume a 20 year life of the facility.
(Hint: In calculating the NPV of the decision to buy the real estate, you only need to consider the incremental cashflows resulting from the decision). NPV=
=11203677.75 – 6,500,00
•The change in incremental cash flow can be examined through looking at the factors causing change in operating income – in this case only the lease cost is different. •The interest repayments are a cost of capital, rather than a cost of operating, and are accounted for in the $6.5 million as a perpetuity outflow of $504,000 giving a present value of $5,750,000. They are therefore not included in the incremental cash flows.
2.TSI values HDC as (5 x EBITDA - debt). Exhibit 3 of the case shows TSI’s valuation of HDC, using EBITDA projected for year 2000, both with ownership of the property and leasing of the property. Explain, in just a few bullet points, the $1.875 million difference in valuations (don’t put any tables in your answer). •EBITDA for owning Lexington is larger by $925k, the amount of the lease (EBITDA does not count cost of interest and depreciation, but includes cost of lease) •5x of that is $4,625k
•The other difference between owning and leasing is amount used to buy Lexington, $6,500k •5x - debt is valuation difference. Multiplication of 5 has massive effects on the valuations, the assumption is that a multiplier of 5 reflects an approximate valuation to the present value of the cash flows.
HDC decides to restructure the ownership of the Lexington club to get around the real estate problem...