Use the following information to evaluate this investment assuming below-line tr

Question

Use the following information to evaluate this investment assuming below-line treatment of capital expenditures: property: 5 office units, contract rents per unit: $2,500 per month; vacancy and collection losses: 14%; operating expenses: $42,000; capital expenditures: 5%. After 5 years this property will be sold for $750,000. The cost of capital is 11%, and the capitalization rate is 9%. The property is currently valued at $1,000,000. Use all the methods from this class to decide whether to purchase this property.

Explanation / Answer

$ Rent revenue ( $ 2,500 per month x 12 months x 5 office units )          150,000 Less: vacancy and collection losses ( $ 150,000 x 14% )           (21,000) Less: Operating expenses           (42,000) Less: Capital expenditure ( $ 150,000 x 5 % )             (7,500) Net cash inflow per annuam             79,500 Computation of net present value Year Cash flow Amount $ Present Value at 11% Discounted cash flow $ 0 Investment in property ( current value )     (1,000,000) 1 (1,000,000) 1 Annual cash inflow             79,500 0.9009          71,622 2 Annual cash inflow             79,500 0.8116          64,524 3 Annual cash inflow             79,500 0.7312          58,130 4 Annual cash inflow             79,500 0.6587          52,369 5 Annual cash inflow             79,500 0.5935          47,179 5 Resale value of property after 5 years          750,000 0.5935        445,088 Net Present Value ( NPV )      (261,088) Investment in property is not finacially viable since the NPV is negative. Therefore, it is not to be invested in this property.

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