6. [10 pts.] Our firm owns a lot suitable for building either five or ten condom
ID: 2798989 • Letter: 6
Question
6. [10 pts.] Our firm owns a lot suitable for building either five or ten condominium units. The firm is considering selling the lot to a real estate developer. Assume that The risk free rate is 8% Per unit construction costs are currently: · * $100,000 per unit if you build five units $115,000 per unit if you build ten units » Construction does not take time The current market price of each unit is $130,000 .Per year rental rate is $10,000 per unit (net of expenses, to be paid at the end of the year) .Next year, if market conditions are: Favorable, condos sell for $160,000 Unfavorable, condos sell for $115,000 a. What is the value of the land? b. Now assume that if the developer builds five units this year, they have the ability to build an additional floor onto the building next year to create an additional five units. Each of the additional units would cost $110,000 to build and the developer would have to purchase one permit from the city for $20,000 in order to build all five additional units. All of the costs would occur at time 1 when the units are built. What is the value of the land?Explanation / Answer
a. If you build 10 units then the cost of construction is 10 x $100,000 = $1,000,000
Market price for each unit = $130,000
Total price if the developer sells the units= 10 x $130,000 = $1,300,000
Profit if units are sold this year = $300,000
Rental income per year of 10 units = 10 x $10,000 = $100,000
Selling price for units next year would be average of both the cases = ($160,000 + $115,000)/2 = $137,500 per unit
And total selling price would be = $137,500 x 10 = $1,375,000
PV of these cash flows would be = ($1,375,000 + $100,000)/(1.08) = $1,365,740
Profit from sale next year = $1,365,740- $1,000,000 = $ 365,740
So value of land = $365,740
b.
If you build 5 units then the cost of construction is 5 x $100,000 = $500,000
Market price for each unit = $130,000
Total price if the developer sells the units= 5 x $130,000 = $650,000
Profit if units are sold this year = $150,000
Rental income per year of 5 units = 5 x $10,000 = $50,000
Selling price for units next year would be average of both the cases = ($160,000 + $115,000)/2 = $137,500 per unit
And total selling price would be = $137,500 x 5 = $687,500
PV of these cash flows would be = ($687,500 + $50,000)/(1.08) = $682,870
Profit from sale next year = $682,870 - $500,000 = $ 182,870
For additional floor next year,
Cost of construction = $110,000 per unit
Cost for 5 units = 5 x $110,000 = $550,000
Permit cost = $20,000
Total cost = $570,000
Selling price for units next year would be average of both the cases = ($160,000 + $115,000)/2 = $137,500 per unit
And total selling price would be = $137,500 x 5 = $687,500
PV of these cash flows would be = ($687,000)/(1.08) = $636,111
Profit from sale next year = $636,111 - $570,000 = $ 66,111
Total value of land = $182,870 + $66,111 = $248,981
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.