CUC Accounting for Decision Making Questions

Please review the attached file. The attached pdf case study is to be used for part 2.

W15174
DOMUS DEVELOPMENTS: TO BUILD OR NOT TO BUILD?
Erica Furgiuele wrote this case under the supervision of Elizabeth M. A. Grasby solely to provide material for class discussion. The
authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised
certain names and other identifying information to protect confidentiality.
This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the
permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights
organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western
University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com.
Copyright © 2015, Richard Ivey School of Business Foundation
Version: 2016-12-14
It was October 2013, and Michael Mescia, project manager of Domus Developments (Domus), was
contemplating the future of the company’s next development project, the North Point Lofts (North Point).
Domus had originally launched this development project in 2008, but for various reasons, it had not yet
come to fruition. With most of Domus’s other development projects currently near completion, Mescia
wondered whether the right time had finally arrived to start work on the long-awaited North Point project.
Mescia wanted to evaluate North Point’s financial outcomes, including Domus’s ongoing cash position
during the building process and its relevant qualitative considerations. Conversely, Mescia wondered how
much the land’s value had appreciated over the years and whether selling the land might be Domus’s most
profitable option. Mescia’s decision should support Domus with its corporate goal of developing an
esteemed reputation in the market.
DOMUS DEVELOPMENTS
Founded in 2000, Domus was a family-owned, residential builder that serviced southern Ontario. The
company was headquartered in London, Ontario, Canada, where a majority of its developments were built
and where Mescia resided.
Over the years, Domus had developed a strong reputation for innovative designs and high-quality
structures. A developer who could design and construct a site that satisfied customers and sold quickly
gave landowners the quickest return on their investment. This outcome was essential in the industry and
had led Domus to its current level of success. In the beginning, Domus had been unable to secure Type A
sites1 because it lacked an established reputation for building development. As a result, the company often
lost jobs to more experienced builders. Over time, and with a focus on quality, customer satisfaction and
innovation, Domus earned a solid reputation amongst landowners, vastly improving its relationships within
the industry and the community. In fact, Domus had received awards for its building development projects
from both the London Home Builders’ Association (LHBA) and Ontario Home Builders’ Association. For
example, in 2013, Domus won the London Urban Design Award for its Woodland Towns project in
1
Developers classified land on a scale based on variables such as location and zoning classifications.
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London, the LHBA award for Best Overall New Home Design for its Port Stanley, Ontario, development,
and the LHBA award for Project of the Year for its River Oaks development in London. Domus currently
operated a corporate website that showcased content on the company’s history, awards received, current
and past development projects and contact information.
LONDON, ONTARIO
With a population of over 365,000, London, Ontario, was the 15th largest city in Canada and the sixth
largest city in Ontario. Situated between Toronto, Ontario (Canada’s largest city), and Detroit, Michigan,
in the United States, and with direct access to some of the province’s major highways, London attracted a
variety of different demographic groups. London was a regional centre for health care and education, and it
was home to several leading hospitals, and two large well-recognized post-secondary education
institutions, Western University (more than 30,000 students) and Fanshawe College (over 15,000 students).
Skilled labourers in various sectors were attracted to the different industries within the city, such as
General Dynamics, McCormick Canada, Labatt Breweries, Dr. Oetker, and 3M Canada. The city also
hosted several prominent music and sporting events at Budweiser Gardens, a 9,000-seat sports and
entertainment facility. London’s downtown was anchored by Richmond row, a shopping district of over
3,200 primarily high-end businesses, including nightclubs, restaurants, higher-end clothing retailers and
professional service providers.
The average Londoner was close to 40 years of age, and the median annual household income was
$74,760, slightly above the Canadian average. Many people considered London to be an ideal place to
retire, and thus, baby boomers over the age of 65 made up 17 per cent of London’s population. Single
detached homes were the city’s most popular dwelling, and 25 per cent of the population lived in
apartments.2
NORTH POINT LOFTS
The Concept
After being approached by a landowner who wanted to develop a Type A site, Domus management was
extremely interested in building an innovative type of home on the land. The project’s concept, called
North Point Lofts (North Point), would be London’s first modern loft residence, inspired by the success
and popularity of modern loft residences in the Toronto market.
North Point would be a four-story building constructed on five acres of highly desirable land in North
London. The building would contain 51 modern lofts, each featuring high ceilings and full-height
windows, and ranging in size from 1,100 to 2,000 square feet. The lofts would also be highly customizable
to cater to the wants and needs of each individual buyer. See Exhibit 1 for a loft’s sample floor plan.
Another key feature was North Point’s location in the city. The building would be constructed on a unique
piece of land, on a hillside, with breathtaking views overlooking London. The building was located just a
few minutes’ drive from one of Northwest London’s largest suburban commercial areas with a mall, a
grocery store, four major banks and numerous other retailers. See Exhibits 2 and 3 for the location and an
initial artist’s concept design for North Point.
2
Statistics Canada website, www.statcan.gc.ca/tables-tableaux/sum-som/l01/cst01/famil107a-eng.htm, accessed March 13,
2015.
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The Customer
North Point would be targeted at Londoners with above-average income levels. Mescia believed the
development would attract empty nesters and older couples who wanted to move upon retirement. Mescia
knew the top decision-making factor in any real estate purchase was location, followed by price.
Preliminary research on the high-end real estate market indicated that exclusivity and customization were
key to these customers. Domus’s development projects had yet to cater to high-end consumers; however,
Mescia saw the North Point project as an ideal growth opportunity for the company. Domus would have to
expand its supplier community to sufficiently source the required high-quality building materials.
September and October 2008
In early September 2008, Domus agreed to purchase the land for development at a market value of $1
million. To secure the purchase of the land, Domus paid $100,000 to the landowners, with the balance due
upon the closing purchase date on all units. After finalizing the concept, Domus hosted its first launch
party to generate excitement around the development project and to attract potential residential buyers. The
party was very successful and resulted in 15 signings3 for the building that same day, based solely on the
concept. While pre-sales were common occurrences in the Toronto housing market, they were new to the
London market, and this early level of interest helped to build Domus’s confidence in North Point’s
potential success as a development.
On September 15, 2008, Lehman Brothers Holdings Inc., a major financial services firm in the United
States, filed for bankruptcy. This incident represented the largest bankruptcy filing in U.S. history and
marked the start of what later became known as the “Global Financial Crisis.” The crisis caused events
never before seen in history, including a record drop in the U.S. Stock Exchange of 7 per cent in one day
on September 28, 2008. Many businesses and financial institutions collapsed, global stock markets
dropped dramatically and, ultimately, the world economy fell into a global recession. The global recession
resulted in the loss of billions in consumer wealth and had a major impact on the housing market. The
economy’s future was highly uncertain, and several key economic indicators of financial stability, such as
employment, declined drastically.
By October 2008, with the financial crisis underway, within a mere month of its highly successful launch
party, Domus saw its initial offers on North Point slowly dissolve. People were revoking their offers due to
uncertainty in the market and, it was believed, likely their own financial uncertainty. Domus’s management
team decided to put the project on hold and instead push forward on less expensive projects.
2009
After the 2008 recession, the Canadian government implemented incentives to encourage Canadians to buy
homes, including the first-time home buyers’ tax credit introduced in 2009 and structural changes made to
registered retirement savings plans (RRSP), giving people the ability to use their savings for a
downpayment on a house. At a later date, these funds were to be repaid to the RRSP over several years.
3
Committing to a purchase secured with signing legal sales agreements and often including an initial payment.
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2010-2011
In early 2010, the subject of North Point resurfaced in company deliberations; however, through word-ofmouth discussions with real estate agents, contacts and clients, it became clear that the market conditions
remained unfavourable for real estate development. The economic recession continued throughout 2011.
2012-2013
By late 2012, economic indicators were starting to show signs of a turnaround in the economy and the
markets. Domus was close to completion on two large development projects, and a third project – Upper
Richmond – had just sold out its first phase in less than eight weeks. These factors convinced Mescia and
the management team at Domus that the residential housing market was improving. In addition, several
customers who had initially shown interest in North Point had recently approached Mescia to inquire about
the timing of the project’s development.
DEVELOPMENT CONSIDERATIONS
Housing Market in London
The Canadian Mortgage and Housing Corporation (CMHC) projected that new construction on
development projects in London would increase by 1 per cent in 2014, amounting to 2,125 new starts. The
CMHC also noted that employment numbers for those between the ages of 45 to 64 were increasing and
the declining unemployment rate to 8.4 per cent in 2014 would continue to support higher-end, new home
construction.4 See Exhibit 4 for other key trends influencing the start of construction in 2014.
The Competition
Surrounding the North Point location, several other building projects were set to take place. North London
was currently the most popular development region in the city because of its undeveloped land in close
proximity to multiple commercial areas and downtown London. See Exhibit 5 for a map of new
developments in North London.
Costs
Mescia put North Point back on Domus’s list of potential projects, but it quickly became evident that the
original design was too outdated for customers in the current market. If Domus decided to relaunch the
North Point project, a costly redesign would be needed, along with a reassessment of building costs, such
as materials and labour. While reviewing these costs, and before commencing the work, Mescia believed it
prudent to compare the cost, on a cash flow basis, of maintaining the land for another year. Lending
options in the construction industry could be complex, but rather than focusing on the financial structuring
of the project, Mescia wanted to focus his analysis on the amount of financing required (if any).
4
CMHC Housing Market Outlook London Area Report Fall 2013.
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Domus would have to hire a team of architects to redesign North Point, at a cost of $500,000 in fees. The
initial design had originally cost $800,000. Once the building process commenced, it would take 14
months to complete the project.
The first step in the building process involved excavating the land to be developed. Excavation would cost
a total of $500,000, expensed equally between July and August of 2014. An external company would be
hired to complete the task, and the price included the use of all equipment, labour and removal of the land
waste from the site.
Based on past projects, Mescia could estimate the amount of labour needed for the development project.
Domus hired contract labourers to complete all tasks, and they supplied their own equipment so there were
no capital investments during the development phase. Fifteen labourers would be needed, each working
eight hours a day, five days a week.5 These labourers would be hired on contract and would average a pay
rate of $15 an hour (including benefits).
The key components of building the structure included concrete, steel and exterior finishings, which
included roofing. These costs would total $1.9 million, $2.5 million, $1 million, respectively. In addition,
windows would cost $725,000 and interior finishings (excluding customization) would total $5 million.
Domus projected that these expenses would be paid in equal monthly installments over the 14 months of
development.
Additionally, Domus incurred holding costs for the land. By law, Domus paid property tax on the land to
the City of London. Annual property taxes cost approximately $40,000 and were paid in April of each
year. Domus also paid interest semi-annually to the landowners on the $900,000 (net amount owed) on the
land at an annual rate of 10 per cent. It was an industry norm that developers receive three years interest
free on the land. Since Domus had already exceeded its three years, until the company could produce a
return to its landowner, interest would have to be paid on the land, with payments due in February and
August of each year. Mescia projected that Domus would continue to pay interest until the development
phase was complete.
Unique to the London market, customers were unaccustomed to buying a property without seeing a
physical model; consequently, Mescia projected that only 14 units of the building would be sold in the presale phase (two months prior to commencement of the building phase). Throughout the building phase,
Mescia estimated that 28 more units would be sold, and the remaining units sold within 12 months after
completion of the development. Sales would be sporadic within these time periods, so Mescia assumed that
no more than two purchases would occur in a single month. To secure their purchases, customers would
have to pay a 10 per cent deposit (up-front) on the loft. Mescia believed the average loft selling price
would be $500,000.
The customization and upgrade option was another key selling feature of the lofts. Mescia knew all
customers would want to customize and upgrade basic features and that each customer would differ on the
amount spent. Some customers would spend as little as $5,000 in upgrades, while others would spend
closer to $50,000. Mescia projected each customer’s spending would average an additional $15,000 for
customization and upgrades. Fees for all upgrades would be included with their deposit when buyers
signed their initial purchase and sale agreement. No profit was made on upgrades.
5
Mescia assumed 23 working days per month.
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Mescia also considered the impact the North Point project would have on his administrator’s workload. He
estimated two hours a day would need to be allocated to the project. The current administrator earned
$42,000 annually, including benefits.
Finally, should additional expenses arise, Mescia budgeted $500,000 in other costs in order to ensure that
the development progressed on schedule without delays. Mescia believed this expense would be incurred
evenly throughout the two years.
Mescia projected total revenue from the sale of the North Point lofts to be $25.5 million based on the
average selling price per unit. As soon as all of the North Point lofts were sold and ownership was
transferred, Domus expected to net a 20 per cent profit on the entire project.
Because the project had been on hold for so long, Mescia, as the landholder, wondered whether the most
profitable option would be to arrange the sale of the land to a competitor. Mescia estimated that the value
of the land had appreciated by approximately 50 per cent over the past five years.
If Domus decided to move forward with the project, construction would begin in July 2014. In May,
Mescia would begin marketing the development. He anticipated the marketing mix to include signage
erected on the site, a feature section on the company website, print advertising in the local newspaper and
in the London Home Builders’ Association directory, as well as a model home. See Exhibit 6 for an
advertisement from the London Home Builders’ Association directory. Mescia’s marketing budget was
$375,000 and would be spent over 24 months.
CONCLUSION
It had been five years since the introduction of North Point, and the Domus team still faced a lot of work to
successfully build the development project. Analyzing both qualitative and quantitative factors, Mescia
was keen on evaluating Domus’s ongoing cash position while building North Point, in addition to
assessing the project’s financial outcomes and its relevant qualitative considerations. Was developing
North Point the right move for Domus Developments?
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EXHIBIT 1: SAMPLE LOFT FLOOR PLAN
Source: Domus Developments.
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EXHIBIT 2: LOCATION OF NORTH POINT LOFTS
North Point
Downtown
Source: Google Maps –– My Maps.
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EXHIBIT 3: NORTH POINT CONCEPT DESIGN
Source: Domus Developments.
EXHIBIT 4 : KEY TRENDS IN LONDON
Source: CMHC Housing Market Outlook Fall 2013. March 13, 2015.
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EXHIBIT 5: NEW DEVELOPMENTS IN LONDON
North Point
Source: www.buzzbuzzhome.com/listview/lat_43.0183/lng_-81.2949/zoom_13/seed_784, accessed March 13, 2015.
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EXHIBIT 6: ADVERTISEMENT FROM LONDON HOME BUILDERS’ ASSOCIATION DIRECTORY
Source: London Home Builders’ Association Directory, January 2015.
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Accounting for Decision Making
Part 1
“Strategy, plans, and budgets are unrelated to one another.” Do you agree? Explain. Explain how the
manager’s choice of the type of responsibility center (cost, revenue, profit, or investment) affects the
behavior of other employees.
Answer should be 250-300 words and please use APA 7th citation.
Part 2
The project manager at a development company is contemplating the future of the firm’s next innovative
development project, which had originally been conceptualized in 2008, but for various reasons, had not
yet come to fruition. The project manager wants to evaluate the venture from a financial viewpoint,
including the company’s ongoing cash position should the company go ahead with the building process;
he also wants to assess other relevant qualitative considerations. Alternatively, the company could sell
the land, which has appreciated considerably in value. All decisions would take into account the
company’s goals and reputation in the industry.
Domus Developments To build or not to build.PDF
Case Study Questions:
1. Identify Domus’ corporate strengths and weakenesses.
2. Analyze the company’s potential customers and the demand for North Point in the current market.
3. What are the pros and cons of developing North Point versus selling the land? What implications
can be drawn from this analysis?
4. Prepare a 24-month cash budget for building North Point, starting in May 2014.
5. As Mescia, what is your decision? Be prepared to defend this decision.
In 3 pages, and applying material from the chapter readings of this module, answer the above
questions. Integrate references (minimum of 3). Reply to these questions in essay (not Q & A)
format. Provide a graduate level introduction paragraph, and conclusion paragraph.
Use the provided writing template, and follow 6th edition APA writing conventions.
10 Points