Done decision.png sult 1 of 1 in this book for The town of Paisley has received

Question

Done decision.png sult 1 of 1 in this book for The town of Paisley has received a proposal to build a new multipurpose outdoor Clean NP 13.15 Decision to Sell or Keep an Asset LO 5, 12 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. NP 13.16 Decision to Replace a Machine LO 5, 9, 12

Explanation / Answer

Present value of keeping the asset:

Present value of selling the asset:

If the building is sold Rich will receive $1.5 million, or $1,500,000 now. As the cash is being received now it will not be discounted and hence its NPV is $1,500,000

As the NPV of selling the building (i.e. $1,500,000) > NPV of keeping the building (i.e. $989,313.86) Rich should sell the building to the developer.

A B C D C*D Year Cash flow from rent Residual value Total cash inflow 1+r PVIF PV 1 200,000 200,000 1.16 0.8621 172,413.79 2 200,000 200,000 0.7432 148,632.58 3 200,000 200,000 0.6407 128,131.53 4 200,000 200,000 0.5523 110,458.22 5 200,000 200,000 0.4761 95,222.60 6 200,000 200,000 0.4104 82,088.45 7 200,000 200,000 0.3538 70,765.91 8 200,000 200,000 0.3050 61,005.09 9 200,000 200,000 0.2630 52,590.60 10 200,000 100,000 300,000 0.2267 68,005.08 NPV 989,313.86

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