Financial Analysis of Construction Project - Example

FINANCIAL ANALYSIS Course Name Professor’s Name Institutional Affiliation City and State Where Institution is Located Date 6.7 Financial analysis This is an analysis of the finances to be used to develop 16-18 Epsom road, Ascot vale. The site has extras such as trees and is a neighbourhood that is generally residential. It is located at ascot vale suburb, Moonee valley council. The locality has various facilities nearby such as a nursing home, a park, a golf course and an education facility. The site can be termed as prime as it can be well accessed through the Epsom road a cyclist route. The area architecturally aesthetic as it features good designs such as Victorians and brilliant designs such as Edwardian. Apart from that, the area has fluidity in roof, structural and fencing construction. These show that the community has values in terms of construction materials and design. The site already has two existing houses, is 40.24m long and 24.38m wide and has an area of 1,015m2 with the land cost being $2,000,000 and construction cost of $1,833,816.19. In order to construct on the property, site clearance is vital. Thus, the existing residential houses must be demolished and huge trees cleared so as to make room for construction of the building. Due to technicalities in construction, several specifics will be initiated during demotion such as use of heavy demolition machinery so as to ensure the building has a steady foundation. This accounts to a total of $162,118.41 preconstruction cost. The proposed building is a three-storey residential apartment block whose deign aligns to the general look of the area. Hence improve the development status of the locality. The planning of the building abides to all neighbourhood standards expect the overlook and fencing standards. The final design is of the area 488m2 and has spacious one bedroom apartments that have a floor area of 67.51m2 on the first floor. The floor plan of the second and third floor is much alike as they have 2 two bedroom houses with a master bedroom, 1 one bedroom apartment and 2 two bedroom apartments without a master bedroom. Further, they feature modern day apartment design such as open kitchen and private balconies. It features a parking space for up to 12 vehicles, a garden, and ESD initiatives. In a bid to honour the initiatives, the proposed building has implemented thermal mass, proper insulation, rainwater tanks and solar panels. In addition, the final design conforms to the adjacent designs thus bringing uniformity in design with the neighbourhood. 6.7.1 Assumptions There are various assumptions of this financial analysis. These input assumptions are majorly in three categories; cost, financing and revenue assumptions. In this scenario they include development costs, rents, vacancy rates, depreciation recovery, tax rates and sale expenses. The proposed building has an assumed 95% occupancy rate and 5% capital rate. The interest rate per annum is 8% and the assumed debt/equity ratio is 50% per year plus maintenance of 2.50% per year. 6.7.2 Cash flow In the construction industry, cash flow in a project is a supply chain. This accounts for the amount of cash and cash equivalents that moves in and out before, during and after Despite the huge construction cost, cash flow into the project runs in the same duration as per the total duration of tasks completion which is 163 days. In accordance, to construction cash flow which includes the land cost, all the phases of the construction including the closure phase and the labour cost. The operation cash flow total is a summation of the cost of each factor monthly. The land cost appreciates over the months due to continued works thus facilitating cash flow implications. Further, cash flow will be high in entities such as land cost and labour cost. Low cash flow entities will be experienced during closure with a cost of $738.60. Meanwhile, the cash flow will be $243,218.73 per month for the land and for the labour it will be $119,705.25 monthly. These costs are highly influenced by the duration a specific entity takes. 6.7.3 Year cash flow The total cash flow in the duration of 10 months taken to fully complete the project is $2,519,217.03. This is a summation of the land cost per month for a duration of 10 months, labour cost per month for a period of 10 months, preconstruction for two months each $81,194.30, construction phase 1 for four months each 68,752.60, construction phase 2 for four months each $113588.70, construction phase 3 for four months each $ 139,621.80, construction phase four for a period of six months each $167,717.97, construction phase 5 for a period of four months each $109,519.47 and closure phase for 10 months each $738.60. In addition due to intervals of specific entities the cash flow monthly varies at a high of $391,860.49 in the 7th month and a low of $79,377.10 in 8th and 9th month. Further, Cash flow shows the actual and accurate cash flow input into the project thus providing basic data on the operating cost of the site on day to day basis. However, cash flow projections may be affected by the need for early purchase of long-lead time items or additional items the client wishes to acquire outside the main contract. This can be accounted for by providing a strategy that aligns the project programme so as to minimise conflict ranging from the client, design consultants and the contractor. Basically, cash flow is always affected by tax. The calculation of CFAT (Cash Flow after Tax) is completed by deducting the taxes paid or adding the tax benefit received to the before-tax cash flow. This is equivalent to applying the tax effect to the operating cash flow reduced by financial payments. In construction projects, CFAT is the appropriate annual cash flow for the evaluation of an equity investment. For analysis purposes, remember that CFAT is composed of two of the three components of a potential return on a real estate investment: cash flow before taxes and the tax effect. 6.7.4 Debt and equity The project has a debt/equity ratio of 50%. This means that the creditors provide 50 cents of each dollar provided by the stockholder to finance the project. Thus in this project since the total construction cost is $2,519,217.03, the total cost provided by the creditor will be $1,239,608.50. This is a satisfactory ratio for the creditors; however the stockholders face a turf challenge of matching with the needs of the project. Further, the ratio indicates the soundness of long term financial policies. It also relates the portion financed by creditors and the portion financed by stockholders. This ratio is always determined by the equity of the stockholder. Thus, when the equity of the stockholder raises the ratio decreases and in cases the creditor increases his portion then the equity of the stockholder lowers. According to (Barrington 2010) a less than 1 ratio indicates that the portion of assets provided by the stockholder is greater than that provided by the creditors while a greater than 1 ratio indicates that the assets provided by creditors is greater than the finances provided by the stockholder. According to (Fantini and Gorga 2009) apartment projects are of choice for both debt and equity players. This is due to a rising demand and the difficult approval process that constricts the supply of new projects. In this case the total cost needed for the project full funding is approximately $3,932,324.06. In order to attain cash flow success during the entire project, a financial help of a construction loan would be advisable. Fantini and Gorga (2009) insist that capital markets are willing to provide funding for development projects, thus financing in the sector has become plentiful. This suggests a correct debt plan would be efficient in this project. 6.7.5 Comparison table Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Yield ($) 219,830 224,236.60 228,711.13 233,285.35 237,951.06 242,710.08 247,564.28 252,515.57 257,565.88 262,717.62 Maintenance ($) 30,000 30,750 31,518 32,306 33,114.39 33,942.25 34,790.80 35,660.57 36,552.09 37,465.89 Cash flow ($) 249,830 254,976.60 260,229.60 265,592 271,065 276,652 282,355 288,176 294,114.97 4,300,183.09 6.7.6 Selling in the 10th year On completion of the subject project, the estimated finances used will be $2,519,217.03. The total loan to be repaid will be $1,259,608.50. However, due to yield, maintenance and repayment the price increases over the years. Due to the assumption of 95% occupancy, the annual yield of the property will be $219,830. The maintenance ratio increases each year from $30,000 in the first year to $37,465.89 in the 10th year. Credit repayment has a constant cost per annum of $204,605.35. This implies that repayment is 93% of yield. In consideration to all the financial factors, selling at the 10th year would be non profitable to the owner. This is due to factors that are deducted from the yield per annum. In addition the Net Present Value (NPV) of the subject property is $1,181,757.86. This means that the value of the property will be positively affected by time over the years. They are various factors that are to be considered in the calculation of the sale price in the 10th year. These factors are mainly land, interest rates, depreciation and inflation. Land is a valuable asset and the land rates will be determined using methods such as the comparable sales method. This method uses data from similar adjacent sales in the recent past to calculate and estimate the value of the land of the subject property, (Mürle, M., Böser, W., 1997). Using assumption figures the rate of depreciation or appreciation of the property will be estimated thus fine tuning the sale price. Inflation rates are measured based on the Gross National Income (GDP) of a particular nation. Even though it is a minor factor, it should be accounted for in the final sale price. 6.7.7 Notes In projects that involve demolition and reconstruction, the cost of construction is usually increased by pre-construction works. However, in order to minimise the cost of construction shown in the BQ (Bill of Quantities) as $2,147,293.15 numerous techniques and appropriate technology can be implemented. These techniques include the recycling of materials demolished to construct site offices, fencing and scaffolds facilities. This will reduce the cost of construction. In addition, time is always a limiting factor in project management. However, this project implements a good policy of constructing in phases from phase 1-5. Despite the labour implications this technique will enable the project be done on time. Basically, the project affects the neighbourhood in a positive manner. This is evident as on completion it will have uniformity with the adjacent buildings. This gives the building a positive review in the area thus attracting high occupancy. In a bid to improve the quality of the building, the designer introduces the use of ESD (Environmental Sustainable Designs) this include the use of solar panels to provide alternate energy. This green energy produces will be used to provide lighting and heat. This reduces the operation costs of occupants as reduces the usage of direct current. In addition, the apartments already feature rain water tanks. In real estate the value of a property is partially determined by its output or rather the services it uniquely offers. Thus rainwater harvesting is a very good intuitive that enables the occupants to benefit from constant water supply. This also reduces the cost of operation as it provides reliable water at efficient price. In a bid to fully implement the ESDs the proposed building has a thermal mass. This cuts on the cost of energy used while also improving the comfort of the building by regulating temperatures in the respective houses. This thermal regulation is supported by eco friendly materials such as floor tiles and building bricks. Clearly, thermal mass improves the quality of the apartments thus affecting the rental prices positively. Further, the building will feature insulating techniques such as sandwiching materials in concrete panels during construction. Appropriate technology such as Batt insulation will be implemented. This affordable technology will ensure insulation while also saving energy. This also makes the building meet the set building regulations in Australia. In conclusion, what counts in a project are correct planning, funding and full and timely implementation (Jeffrey, A. Frankel, 2000). This will produce a quality outcome which in turn provides a positive output. The proposed building will improve the development of the area while also providing income to the owner. Thus, the profitability of the building will increase over the years due to the decrease of the long-term debt, reduction of operation costs and the provision of quality assets. References Fintina, Gorga (2009) Observations, Debt and Equity for construction projects: The Changing Landscape, Boston. Mürle, M., Böser, W., 1997, Comparable method of valuation for real estate – represented for plots with terrace houses in the city Karlsruhe, Zeitschrift für Vermessungswesen (ZfV), 9000, pages 235-243, Stuttgart, Deutscher Verein für Vermessungswesen e.V. Jeffrey, A. Frankel, 2000, financial analysis of real estate property, National Bureau of Financial Research, Cambridge Barrington W, 2010, Debt/ Equity ratio, Journal of finance, vol 3, no. 1 Pg no. 28-45. Richard C, Chantal S, 2010, finance and real Estate, Auburn, Alabama Read More