If Mehmet’s scenario is realized, what would be the return of the project?

Ahmet and Mehmet are partners of DreamHouses Constructing Company. They build and sell houses in suburbs of Ankara. They acquired 15,000 m2 of land with a price of 12,000,000 TL. They expect that the project will last for 5 years, finishing 60 houses of 100 m2 each year and they can sell them with an average price of 250,000 TL. They predict that the project’s variable expenses (material, labor, and project overheads) be equal to 40% of the sales revenue of the first year and will increase by inflation rate in the following years. Fixed costs are projected to be 1000,000TL in the first year and increase with inflation. 4,000,000TL of machinery and equipment investment is needed to realize the project; the equipment can be sold at 3,000,000 TL at the end of the project. Before starting the project engineering, insurance, etc. expenses need to be spent 1,000,000 TL. The tax rate is 20%. The company expects a return of 5% above inflation on the project. However, Ahmet and Mehmet do not agree on the inflation forecasts. For the next 5 years, they respectively estimate the rates to be 10% and 12%. Both partners believe that they should not increase their sales prices. However, Mehmet suspects that other companies might start housing projects in that area, therefore they might need to make discounts: 10% in the 4th year and 15% in the 5th year. On the contrary Ahmet is optimistic and considers that demand will be high so that houses can easily be sold without discount. They consulted Eda to study the financial feasibility of the project. She performed an analysis based on the assumptions of Ahmet. The project’s payback period is found to be 3 years and the internal rate of return 21.24%. Ahmet also questioned about what the monetary return would be. Eda replied that, the net present values would be approximately 2,500,000TL. (a) Are the calculations of Eda correct? (b) If Mehmet’s scenario is realized, what would be the return of the project?

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