8. You manage a real estate investment company. One year ago, the company nity f

Question

8. You manage a real estate investment company. One year ago, the company nity for t five of purchased 10 parcels of land distributed throughout the commu $10 million each. A recent appraisal of the properties indicates tha the parcels are now worth $8 million each, while the other five are w $16 million each. Ignoring any income received from any taxes paid over the year, calculate the investment company's ac ing earnings and its economic earnings in each of the following cases: a. The company sells all of the properties at their appraised values today. b. The company sells none of the properties. c. The company sells the properties that have fallen in value and keeps the properties and count- the others. d. The company sells the properties that have risen in value and keeps the others. e. After returning from a property management seminar, an employee recommends that the company adopt an end-of-year policy of always selling properties that have risen in value since purchase and always retaining properties that have fallen in value. The employee explains that, with this policy, the company will never show a loss on its real estate investment activities. Do you agree with the employee? Why, or why not?

Explanation / Answer

1) The company sells all of the properties at their appraised values today.

Solution: Accounting Income: $20 million; Economic Income: $20 million

Working: Accounting Income = 5*$16 million + 5*$8 million -$100 million = $20 million.

Economic is the rise in the market value of the land, whether sold or not, over the period. At the end of the first year, it equals $20 million

2) The company sells none of the properties.

Solution: Accounting Income: 0; Economic Income: $20 million

Working: Economic Income = 5*$16 million + 5*$8 million -$100 million = $20 million.

3) The company sells the properties that have fallen in value and keeps the others

Solution: Accounting Income: -$10 million; Economic Income: $20 million

Working: Accounting Income: 5*$8 million - 5 *$10 million = -$10 million

Economic Income = 5*$16 million + 5*$8 million -$100 million = $20 million.

4) The company sells the properties that have risen in value and keeps the others.

Solution: Accounting Income: $30 million; Economic Income: $20 million

Working: Accounting Income: 5*$16 million - 5 *$10 million = $30 million

Economic Income = 5*$16 million + 5*$8 million -$100 million = $20 million

5) After returning from a property management seminar, and employee recommends that the company adopt and end-of-year policy of always selling properties that have risen in value since purchase and always retaining properties that have fallen in value. The employee explains that, with this policy, the company will never show a loss on its real estate investment activities. do you agree with the employee? Why, or why not?

Solution: When market value of a piece of land decreases, the owner suffers losses whether he sells or not. The market price of the land decreased because people thought the future income stream to the owners was worth less. Continuing to hold such property, forces the owner on acceptance to the lower income. Whether the loss is recognized or not might not impact the accounting earnings, however reality has nothing to do with it.

Related Questions

Navigate

• Browse (All)
• Browse 8
• Subjects

---

---

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