Question: (Samuelson-McKean) Suppose the risk-free (i.e., government bond) interest rate is 5%, the current cash yield payout rate on newly built property is 7.5%, and the annual volatility of individual property total returns is 25% for built properties that are leased up and operational. Use the Samuelson-McKean formula to answer the following questions concerning a vacant but developable land parcel.
a. If built property has a 4% risk premium in its expected total return (9% total return), what is the risk premium and expected total return for the land parcel?
b. What is the value of the land parcel if a building currently worth $2,500,000 new could be built on the land for a construction cost of $2,200,000?
c. What is the hurdle benefit/cost ratio above which the land should be developed immediately?
d. What value of newly built property does this suggest is required before the land should be developed?
e. Under these conditions, should the land be developed immediately or is it better to wait?