The McCaffreys find themselves in a difficult situation as they have committed land for a development project that is now experiencing numerous problems. They are faced with tight deadlines and a complex set of factors that required me to carefully review the Case Study multiple times in order to fully understand. At the beginning of the Phoenix project, there were essentially three main elements to manage. The first was the Village of Woodland, where the land was situated, which had agreed in a verbal agreement to provide $4.1 Million in subsidies to enhance a community eyesore.
At first, this was a significant advantage for the project. However, both the project and the $4.1 Million had to be approved by the board in order to become official. There was no guarantee of receiving the funds yet. The second challenge arose with their loan as Bank One reduced their offer to $2 Million due to a lower-than-expected project appraisal. They also required MACD to acquire a $500,000 line of credit from another source before granting the loan. Furthermore, the loan approval depended on MACD securing a signed purchase and sale agreement for one of the buildings. The final aspect involved buying the land itself.
The landowner was a tough negotiator, and despite 9 months of negotiations, the two parties remained $75,000 apart in the purchase price. Colleen acknowledged the high risks and rewards involved. She emphasized the importance of not making any mistakes. However, as the case progressed, the odds seemed to be against MAC Development. More complications arose on top of the initial risks. Harwich Bank and Trust withdrew from their agreement for a $500,000 line of credit because Bank One had already claimed all the collateral. Additionally, MACD found a buyer for the first building, but the Village rejected the offer.
The broker they had hired was not being effective in finding new buyers for their development deals, as it required more effort and time to earn a commission. They felt understaffed and considered hiring Jim, the youngest McCaffrey, to assist with the deal. The terrorist attacks on September 11, 2001, profoundly impacted the country and were likely to cause a recession. The company had dedicated two years of time and effort, as well as $311,500 of their own and investors’ money. If they decided to give up on the project, they risked potentially losing all that investment. Their risks were interconnected, and with a recession looming ahead, there was no margin for errors.
In my opinion, Dick has been overly optimistic about the project, giving most of these factors the benefit of the doubt. The $4.1 Million subsidy package was only verbal, which in business is worthless. He and his team got excited when they discovered cheap land with free government TIF money available and began investing more time and money until they ended up in this situation. He has risks that depend on other risks, such as the Bank One loan requiring a purchase and sale agreement, but the Village of Woodland has the power to reject the purchase and sale agreement of any potential buyers.
Despite this, he has effectively managed his responsibilities and cannot predict when market crashes will occur. At times, developers find themselves in challenging situations like this project. It would have been beneficial if they had alternative deals in progress instead of risking all of the team’s time and the investors’ funds on a single deal. Although he has dealt with similar issues in the past, he should have avoided such deep involvement from his team. He must now decide whether to abandon ship or proceed at full speed. Ultimately, what is worse: losing 300K or forfeiting a bank-owned multimillion dollar vacant business park due to payment inability?
The speaker expresses desperation and emotion rather than logic in their final comments. They mention that when someone is destitute and trapped, they have two options – either succeed or go bankrupt. The question of whether we would take such a risk with our time and money if we were wealthy often comes to mind. Sometimes, it feels like moving forward is the only choice. The project claims to have an overall internal rate of return (IRR) of 47.7%, based on the given assumptions. However, it’s possible that the investors are unaware of the actual uncertainty surrounding these assumptions. In my opinion, the likelihood of the project proceeding as planned and the cash flows aligning with projections is extremely low, especially when considering potential complications.
The total return is divided into three categories of investors: A, B, and C. Class A investors receive the least risk by choosing a guaranteed return of 25%. They are the first to be paid from the cash flows and once they receive their 25%, they are considered fully paid and removed from the investment. Any group that allows their cash to be used as working capital receives a bonus return. After receiving the bonus, Class A achieves an overall internal rate of return (IRR) of 30.63%. Class B is guaranteed a return of 20% and takes on some development risk with MAC Development by capturing 32.4% of the future cash flows.
After 12 years, when the government tax refunds expire, Class B investors earn a 36.95% return on their investment. A unique position lies with Class C, the McCaffreys, as their equity investment and the time spent on the project are both considered. Class C is structured to receive an 18% guaranteed return, being paid last but gaining 67.6% of all future cash flows. Due to their efforts and assumption of development risk, the McCaffreys achieve an impressive IRR of 88.9% for their contribution. Their total earnings over 12 years amount to $2,651,499, reflecting these significant returns if the project goes as planned. While the purchase price of the land has some impact on the return, it is not particularly significant and will be further discussed below. With limited time remaining and many tasks at hand, the McCaffreys must act quickly. The most productive use of their time with the Village would be to convince them to allow the current buyer that they have lined up, emphasizing his trustworthiness, quality business, job prospects, and other favorable factors.
Dick must inform the Village about the impact of the September 11 attacks on the economy, which will likely lead to a recession. He emphasizes that they must be adaptable in order to proceed with the project and prevent it from remaining deserted. In terms of securing the loan from Bank One, they need to immediately start searching for a $500,000 revolving line of credit. However, they can negotiate with Bank One to potentially reduce this amount to $250,000. The silver lining of the current situation is that a recession might result in lower interest rates.
The McCaffreys should explore other banks’ offers for the project, considering the possibility of finding a loan with a 75% LTV. When it comes to the final purchase price, Dick must exercise caution as $75,000 will not jeopardize the deal in the grand scheme of things. To move forward, Dick should be prepared to pay the seller’s asking price and prioritize more important matters. I recommend accepting the current price but with a condition that addresses and resolves the land valuation problem faced by the seller. This issue impacts subsidies which significantly affect cash flows. Additionally, the McCaffreys should search for another potential buyer for one of their buildings in case their current prospect is rejected again. Even if they secure approval from the first buyer, selling multiple buildings will enhance their investment and validate projections while fostering stability among all parties involved. The McCaffreys still have an opportunity to salvage this situation by concentrating efforts, acting confidently, and responding swiftly. However, failure would result in a much larger loss than what is presently invested ($311,500). They need to approach this situation realistically and logically rather than emotionally. Regardless of outcomes, I agree with Dick McCaffrey that under existing circumstances it is either succeed or face bankruptcy.
