Larry Yung, Chairman of Citic Pacific Limited, has a decision to make. He must decide if he should invest in property and build the “Citic Tower II”. Under the current conditions, the current net present value is negative, which is one of the factors that Larry is using to decide. Another concern is that the commercial real estate market is very cyclical in the area. Also, with the current economic conditions, there is not really a guarantee that the “Citic Tower II” will survive in the area, which another concern for Larry Yung. In terms of the positives for this investment, the location of this building is prime as it is located attracted the banking and financial sectors, and special accounting and legal firms. Also, Citic Tower has maintained its occupation rate, according to the case, even after the economic crisis that hit Asia. After seeing these benefits and concerns of this property, Larry Yung must decide if his company wants to invest in the property.
As net present value is a factor that Larry Yung uses to make decision; it has to reflect a positive number in order for him to convince the board with a go-head to the project. Under the condition where there is no flexibility, managerial discretion or strategic actions, the net present value of the project will solely be the present value of cash flow subtracts the cost of the project. In numerical term, the asking price of HK$ 1 billion dollar has a present value of HK$ 1.54 with a cost of HK$ 1.6 billion. This leads to a net present value of HK$ (60 million) dollar. This makes the project very unattractive. Therefore, different approach is used to examine whether or not the project is profitable.
Weighted average cost of capital is used in the discounted cash flow method that shows the case of Citic Tower II becomes more attractive. Based on the DCF analysis stated in figure 1, the option to defer development for 6 months provides Citic Pacific Limited (CFL) with the greatest opportunity....
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