Question

Ben Ryatt, professor of languages at a southern university, owns a small office building adjacent to the university campus. He acquired the property 12 years ago at a total cost of $770,000—$49,000 for the land and $721,000 for the building. He has just received an offer from a realty company that wants to purchase the property; however, the property has been a good source of income over the years, so Professor Ryatt is unsure whether he should keep it or sell it. His alternatives are:

   

Keep the property. Professor Ryatt’s accountant has kept careful records of the income realized from the property over the past 10 years. These records indicate the following annual revenues and expenses:

  

  Rental receipts

$

173,000

  Less building expenses:

     Utilities

$ 30,200

     Depreciation of building

19,700

     Property taxes and insurance

21,300

     Repairs and maintenance

12,200

     Custodial help and supplies

45,200

128,600

  Net operating income

$

44,400

Professor Ryatt makes a $14,200 mortgage payment each year on the property. The mortgage will be paid off in 10 more years. He has been depreciating the building by the straight-line method, assuming a salvage value of $9,700 for the building, which he still thinks is an appropriate figure. He feels sure that the building can be rented for another 16 years. He also feels sure that 16 years from now the land will be worth 2.50 times what he paid for it.

   

Sell the property. A realty company has offered to purchase the property by paying $210,000 immediately and $31,000 per year for the next 16 years. Control of the property would go to the realty company immediately. To sell the property, Professor Ryatt would need to pay the mortgage off, which could be done by making a lump-sum payment of $92,000. Professor Ryatt requires a 12% rate of return. (Ignore income taxes.)

  
Click here to view Exhibit 8B-1 and Exhibit 8B-2, to determine the appropriate discount factor(s) using tables.

  

Required:

a.	Calculate the net present value of cash flows using total cost approach if he keeps the property. (Any cash outflows should be indicated by a minus sign. Round discount factor(s) to 3 decimal places and intermediate calculations to nearest dollar amount.)

Item	Year(s)	Amount of Cash Flows	12% Factor	Present Value of Cash Flows
Keep the property:
Annual loan payment	1-10
Annual net cash inflow	1-16
Resale value of the property	16
Present value of cash flows				$0

b.

Calculate the net present value of cash flows using total cost approach if he sells the property. (Any cash outflows should be indicated by a minus sign. Round discount factor(s) to 3 decimal places and intermediate calculations to nearest dollar amount.)

Item	Year(s)	Amount of Cash Flows	12% Factor	Present Value of Cash Flows
Sell the property:
Payoff of mortgage	Now
Down payment received	Now
Annual payments received	1-16
Present value of cash flows				$0

c.	Would you recommend he keep or sell the property?
	Sell the property Keep the property

Answer 1

a.

Item	Year(s)	Amount of Cash Flows	12% Factor	Present Value of Cash Flows
Keep the property:
Annual loan payment	1-10	-14200	5.6502	-80232.84
Annual net cash inflow	1-16	64100	6.974	447033.4
Resale value of the property	16	132200	0.1631	21561.82
Present value of cash flows				388362.38

b.

Item	Year(s)	Amount of Cash Flows	12% Factor	Present Value of Cash Flows
Sell the property:
Payoff of mortgage	Now	-92000	1	-92000
Down payment received	Now	210000	1	210000
Annual payments received	1-16	31000	6.974	216194
Present value of cash flows				334194

c. He should keep the property as the PV of cash flows is more