Your firm is considering purchasing an old office building with an estimated rem

Question

Your firm is considering purchasing an old office building with an estimated remaining service life of 25 years. Recently, the tenants signed a long-term lease, which leads you to believe that the current rental income of $300,000 per year will remain constant for the first five years. Then the rental income will increase by 20% for every five-year interval over die remaining life of the asset. That is, the annual rental income would be $360,000 for years 6 through 10, $432,000 for years 11 through 15, $518,400 for years 16 through 20, and $622,080 for years 21 through 25. You estimate that operating expenses, including income taxes, will be $87,000 for the first year and that they will increase by $6,000 each year thereafter. You also estimate that razing the building and selling the lot on which it stands will realize a net amount of $51,000 at the end of the 25-year period. If you had the opportunity to invest your money elsewhere and thereby earn interest at the rate of 13% per annum, what would be the maximum amount you would be willing to pay for the building and lot at the present time?

Explanation / Answer

Years Rental Income Operating expenses including Income Tax Net realizable amt at year 25 Net Income   Discount rate @13% PV of cash Flows Year 1        300,000               87,000       213,000          0.885          188,496 Year 2        300,000               93,000       207,000          0.783          162,111 Year 3        300,000               99,000       201,000          0.693          139,303 Year 4        300,000            105,000       195,000          0.613          119,597 Year 5        300,000            111,000       189,000          0.543          102,582 Year 6        360,000            117,000       243,000          0.480          116,717 Year 7        360,000            123,000       237,000          0.425          100,739 Year 8        360,000            129,000       231,000          0.376            86,893 Year 9        360,000            135,000       225,000          0.333            74,899 Year 10        360,000            141,000       219,000          0.295            64,515 Year 11        432,000            147,000       285,000          0.261            74,299 Year 12        432,000            153,000       279,000          0.231            64,367 Year 13        432,000            159,000       273,000          0.204            55,737 Year 14        432,000            165,000       267,000          0.181            48,241 Year 15        432,000            171,000       261,000          0.160            41,731 Year 16        518,400            177,000       341,400          0.141            48,307 Year 17        518,400            183,000       335,400          0.125            41,998 Year 18        518,400            189,000       329,400          0.111            36,502 Year 19        518,400            195,000       323,400          0.098            31,714 Year 20        518,400            201,000       317,400          0.087            27,545 Year 21        622,080            207,000       415,080          0.077            31,878 Year 22        622,080            213,000       409,080          0.068            27,802 Year 23        622,080            219,000       403,080          0.060            24,243 Year 24        622,080            225,000       397,080          0.053            21,135 Year 25        622,080            231,000        51,000       442,080          0.047            20,823 Present value      1,752,173 So maximum amount that can be paid for the building and the lot = $ 1,752,173

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.