(Oscar\'s Office Building) Oscar is considering getting into the real estate bus
ID: 403344 • Letter: #
Question
(Oscar's Office Building) Oscar is considering getting into the real estate business. He's looking at buying an existing office building for $1.8 million in cash. He wants to estimate what his return on invested capital (ROIC) will be on an annual basis. The building has 14,000 square feet of rent-able space. He'd like to set the rent at $4.00 per square foot per month. However, he knows that demand depends on price. He estimates that the percentage of the building he can fill roughly follows the equation: % Occupied = 2 - 0.3*Rent (rent is in dollars per square foot per month) So, at $4.00, Oscar thinks he can fill about 80% of the office space. Oscar considers two categories of costs: variable costs, which are a function of the square feet occupied, and fixed costs. Fixed costs will be $8,000 per month and include such items as insurance, maintenance, and security. Variable costs cover such things as electricity and heat and run $1.25 per month for each square foot occupied. a. What is the ROIC? b. What would be the new ROIC if Oscar decides to charge rent of $5.00 per square foot per month?Explanation / Answer
Rent Profit every month (consider % of occupied)
= $(4 - 1.25) / square * 14,000 * 80%
= 30,800
Rent Profit per year
= 30,800 * 12
= $ 369,600
ROIC
= 369,600 / 1,800,000
= 20.53%
If the rent increase to 5.00 per square per month
% of occupied = 2 - 0.3 (5) = 50%
Rent Profit every month (consider % of occupied)
= $(5 - 1.25) / square * 14,000 * 50%
= $ 26,250
Rent Profit per year
= 26,250 * 12
= $ 315,000
ROIC
= 315,000 / 1,800,000
= 17.5%
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