An investor owns a whole level of an old office building which is currently worth $1 million. There are three mutually exclusive projects that can be started by the investor. The office building level can be:
- Rented out to a tenant for one year at $0.1m paid immediately, and then sold for $0.99m in one year.
- Refurbished into more modern commercial office rooms at a cost of $1m now, and then sold for $2.3m when the refurbishment is finished in one year.
- Converted into residential apartments at a cost of $2m now, and then sold for $3.4m when the conversion is finished in one year.
All of the development projects have the same risk so the required return of each is 10% pa. The table below shows the estimated cash flows and internal rates of returns (IRR's).
|Mutually Exclusive Projects|
|Project|| Cash flow
| Cash flow in
one year ($)
|Rent then sell as is||-900,000||990,000||10|
|Refurbishment into modern offices||-2,000,000||2,400,000||20|
|Conversion into residential apartments||-3,000,000||3,400,000||13.33|
Which project should the investor accept?