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.
| The present value of rent to be received for 10 yrs and the value of property after 10 yrs | |||||||||
| Years | Cash flow | Discounting factor @ 16% | Present value | ||||||
| 1 | 200000 | 0.862068966 | 172413.8 | ||||||
| 2 | 200000 | 0.743162901 | 148632.6 | ||||||
| 3 | 200000 | 0.640657674 | 128131.5 | ||||||
| 4 | 200000 | 0.552291098 | 110458.2 | ||||||
| 5 | 200000 | 0.476113015 | 95222.6 | ||||||
| 6 | 200000 | 0.410442255 | 82088.45 | ||||||
| 7 | 200000 | 0.35382953 | 70765.91 | ||||||
| 8 | 200000 | 0.305025457 | 61005.09 | ||||||
| 9 | 200000 | 0.26295298 | 52590.6 | ||||||
| 10 | 200000 | 0.226683603 | 45336.72 | ||||||
| 10 | 100000 | 0.226683603 | 22668.36 | ||||||
| 989313.9 | |||||||||
| The present value of the rent income and the value of property is $989313.90 | |||||||||
| The developer is offering $ 1.5 million which is $1500000 | |||||||||
| The Rich landlord should accept the developers offer as he would be earning more with the offer | |||||||||
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