1 & 2) I allocated the purchase costs in three different ways. I am recommending that the real estate corporation allocate costs using the following method because it maximizes the project’s Net Present Value (and will make Nella Lyrrad look the best when she reports the project’s results to her superiors!):
Cost Allocation Based on What the Developers Spent
The developers spent $100 million on the land, $100 million on the recreation facilities, & $100 million on streets, parks, utilities, lots, & greenways. Based on these expenditures, I first allocated half of the $33 million purchase price ($16.5 million) to the recreation complex under the assumption that the $100 million recreation expenditures plus ½ of the $100 million land expenditures were related to the recreation complex. Next, I allocated $10,000 to each of the 500 finished lots ($5 million total), since that was the stated cost to complete each unfinished lot. This left $11.5 million of the $33 million purchase price to still be allocated ($33 - $16.5 - $5). I divided the remaining $11.5 million by the total number of lots to be sold (25,000, including finished & unfinished) to get a cost per lot of $460. I multiplied this amount by the number of lots that were sold each year, including to the finished lots that were sold in 1992. This allocation method resulted in a Net Present Value for the project, at 12%, of $124,290,018.
I tried two other cost allocation methods, but they both resulted in lower Net Present Values than the method described above. I am not recommending that the real estate company use either of these methods, but will describe them nonetheless:
Cost Allocation Based on the Real Estate Corporation’s Assessed Values
The real estate corporation assessed the total value of the property at $100 million, with $89 million attributable to the unfinished lots, $1 million attributable to the finished