Rich Landlord owns a dilapidated 30-year-old apartment building in Bristol. The

Question

Rich Landlord owns a dilapidated 30-year-old apartment building in Bristol. The net cash flow from renting the apartments last year was $200,000. He expects those net cash flows from renting the apartments to continue for the remaining useful life of the apartment building, which is 10 years. In 10 years, the value of the property is expected to be $100,000. A developer wants to buy the apartment building from Rich, demolish it, and construct luxury condominiums. He offers Rich $1.5 million for the apartments. Rich’s opportunity cost of capital is 16 percent. Assume that Rich pays no taxes.

Evaluate the developer’s offer and make a recommendation to Rich.

Explanation / Answer

The present value of rent to be received for 10 yrs and the value of property after 10 yrs Years Cash flow Discounting factor @ 16% Present value 1 200000 0.862068966 172413.8 2 200000 0.743162901 148632.6 3 200000 0.640657674 128131.5 4 200000 0.552291098 110458.2 5 200000 0.476113015 95222.6 6 200000 0.410442255 82088.45 7 200000 0.35382953 70765.91 8 200000 0.305025457 61005.09 9 200000 0.26295298 52590.6 10 200000 0.226683603 45336.72 10 100000 0.226683603 22668.36 989313.9 The present value of the rent income and the value of property is $989313.90 The developer is offering $ 1.5 million which is $1500000 The Rich landlord should accept the developers offer as he would be earning more with the offer

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