Case study 3

Learning Goal: I’m working on a business question and need a sample draft to help me learn.

Read the “Office Space, A Company’s Frontier: The Corporate Decision to Buy or Lease” (attached below) case study and answer the questions below. Please submit your write-up and excel workbook with your discounted cash flow (DCF) analysis to Canvas on or before Wednesday, April 13th, 2022, at 5:29 pm eastern standard time. Groups of no more than 5 or 6 are allowed (free to choose your own groups). This assignment is graded for completeness (answering all the questions), effective write-up (clear and free of grammatical errors), and thoughtfulness of your answers (demonstrate knowledge and critical thinking). See the case study rubric for additional information, including guidelines and grading criteria.

Business Assumptions:

  • Assume that Drechtal receives approval of their first oncology drug, Trianoline.
  • Equity is limited. Whatever equity Drechtal will need to purchase its headquarters could alternatively be invested in its core business, should it not purchase its headquarters.
  • Every dollar Drechtal invests in its core business generates cash flow equal to 9.132% of the investment. At the same time, the investment’s value grows by 2% annually. (This means that the cash flow generated by new investment is also growing at 2%.)
  • The depreciable life of all new pharmaceutical investments is 10 years.
  • In Switzerland, both the corporate tax rate and the capital gains tax rate are 18% (both price appreciation and depreciation recapture).
  • Drechtal’s CFO is confident that given its current capital structure (approximately 57% debt), its required return on equity (for its core business) is 22%.
  • Drechtal can borrow in the Swiss bond market at 2% up to a 10-year maturity, with annual coupons on the bonds and no amortization. Should Drechtal invest in its core business, it will initially borrow at time 0 in the Swiss bond market so that its initial capital structure is unchanged. Drechtal will not adjust its debt holdings going forward.

Lease-Buy Assumptions:

  • Office tenants in Basel sign 10-year NNN leases, with a 5% step-up in rent in Year 5.
  • A single-tenant A-quality office building with a long lease typically incurs capital expenditures equal to roughly 16% of NOI.
  • The new building under construction will be of much greater quality than neighboring buildings, and will therefore likely attract tenants with rents roughly 20% above the current “prime” level for the neighborhood.
  • Total expenses (operating + vacancy/credit) of a new Swiss office building are 34% of gross rent if the building is professionally managed. Expenses incurred by corporate owners are typically 10% higher. This can be calculated not as 44% of the rent, but rather (1 + 10%)*(34%*gross rent).
  • Property sales brokers charge a 3% commission upon sale.
  • Swiss commercial property valuation in Basel is approximately 80% structure and 20% land. The depreciable life of Swiss property is 20 years. You may not depreciate land in Switzerland.

Part 1. Renew Current Leases, Move and Consolidate, or Buy New HQ?

Based on the information provided in the case study and DCF analysis for each option, do you recommend for Drechtal to (1) continue leasing as-needed and renew their current leases, (2) move and consolidate employees in leased space, or (3) acquire their own corporate headquarters?

  • Discuss your rationale based on considerations, for example, with regard to the long-term strategy, operational needs of the firm, and property market conditions.
  • Discuss strategic considerations with regard to the financing options.
  • Discuss any relevant financial considerations raised by DCF analysis for each option. For the DCF, use the information provided in the case study and conduct analysis on an after-tax basis (Assume a 10-year holding period where any property purchased is sold at the end of 10-years).

Part 2. Evaluate the Opportunity Cost With Respect to the Core Business

Work through sensitivity analysis that considers different rates of return on investments and growth for the core business. How is your answer in Part 1 impacted by potential changes in Drechtal’s core business? (Hint: what happens when you adjust the dividend rate and annual growth rate on Drechtal’s investment in their core business?)

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