Your firm is considering developing an apartment complex. The firm owns land tha

Question

Your firm is considering developing an apartment complex. The firm owns land that could be used for the project; it was bought last year for $500,000. Real estate has gone up sharply in the last year: the land could be sold today for $625,000. Real estate values are expected to increase at 5 percent per year going forward from today. The permitting fees and sewage infrastructure development required for development cost $250,000 (the bill is due now and the project could not have proceeded without this work). This expense will be depreciated over the 30-year life of the project. The apartment buildings will be four-plex townhouses (i.e. buildings that have four apartments each). Each apartment will rent for $1,000 per month. Initially, your firm will build 20 townhouses; if the project is successful, there is space on the land for as many as twenty more townhouses. Each townhouse will cost $120,000 and will be depreciated straight-line to zero over the 30-year life of the project. In addition, the project will require a net working capital investment of $20,000 today—this amount will be recovered at the end of the project. At the end of the project, the townhouses will be completely trashed—the plan is to demolish them and sell the land. Demolition costs will be $150,000 before tax. Your variable cost is $1,250 per year per townhouse. Fixed costs are $130,000 per year. Your firm’s tax rate is 34% and the cost of capital is 10% . Find the NPV

Explanation / Answer

NPV:

Workings

No of town houses = 20

No. of apartment in each townhouse = 4

Rental income per town house per year = 1000*4*12

= 48000

Total Rental income per year = 48000*20 = 960000

Statement showing Cash flows after tax

Particulars

Amount

Rental income per year

960000

Less: Variable cost (1250*20)

25000

Less: Fixed cost

130000

CFBT

805000

Less: Tax @34%

273700

Add: tax savings on depreciation (88333*34%)

30033

CFAT

561333

Depreciation per year = (250000+120000*20)/30

= 88,333

Value of land after 30years = 500000(1.05)30

   = $2,058,068

Note: capital gain Tax has not been considered on sale of land due to absence of information regarding capital gain tax

Statement showing NPV Particulars Time PVF Amount P.V Cash out flow Permit fee 0 1 250000 250000 Town house developement cost 0 1 2400000 2400000 Working capital investment 0 1 20000 20000 P.V of cash outflow A 2670000 Cash inflows Operatinf CFAT 30-Jan 9.427 561333 5291686 Sale of land 30 0.057 2058068 1174000 Demolition cost 30 0.057 -99000 -56430 Working capital released 30 0.057 20000 1140 P.V. of cash inflows (B) 6410396 NPV (B-A) 3740396

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