1. You own an undeveloped piece of property upon which you can build an office c
ID: 2762484 • Letter: 1
Question
1. You own an undeveloped piece of property upon which you can build an office complex. Twenty years ago you paid $40,000 for the land. Similar properties are now selling for $200,000. To build the complex will require an initial investment of $150,000 and the offices would generate rental income of $24,000 a year forever. If the discount rate is 14%, should you build the office complex? Why or why not?
2. Suppose a firm is considering moving its headquarters to a new city. Last year it paid $500,000 for an option to buy a building in the city: the option gives it the right to buy the building at a cost of $3,000,000, so that its total expenditure will be $3,500,000 if indeed it buys the building. Now it finds that a comparable building has become available in the same city at a price of $3,250,000. Which building should it buy? Why?
3. A proposed new investment has projected sales of $450,000. Variable costs are 40% of sales, and fixed costs are $100,000. Depreciation is $75,000. Prepare a pro forma income statement assuming a tax rate of 40%. What is the projected net income? What is the operating cash flow?
4. A proposed new project will last for three years and requires the purchase of a lorax machine costing $90,000. The project has projected annual sales of $135,000, annual costs of $80,000, and annual depreciation of $30,000. The tax rate is 30%. Calculate operating cash flow. If the project also requires an immediate investment in net working capital of $15,000, what is the project’s NPV? Assume the discount rate is 9%.
Explanation / Answer
1) Present value of perpetuity = rent per year / interest rate
= 24000/14% = $ 171,429 which is less than the present value of the land. so the company should not build the building.
2)
Company should go for building which costs less. In this case it is $3,250,000.
3)
Sales 450,000 Variable cost 180,000 Fixed cost 100,000 Operating income 170,000 Depreciation 75,000 Income after depreciation 95,000 tax @ 40% 38,000 net income 57,000Related Questions
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