Question

Barton Laski, 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 $700,000—$65,000 for the land and $635,000 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 Laski is unsure whether he should keep it or sell it. His alternatives are:

  

Keep the property. Professor Laski’s accountant has kept careful records of the income realized from the property over the past 9 years. These records indicate the following annual revenues and expenses:

  

Rental receipts		$	166,000
Less building expenses:
Utilities	$ 29,500
Depreciation of building	19,000
Property taxes and insurance	20,600
Repairs and maintenance	11,500
Custodial help and supplies	44,500		125,100
Net operating income		$	40,900

  

Professor Laski makes a $13,500 mortgage payment each year on the property. The mortgage will be paid off in 9 more years. He has been depreciating the building by the straight-line method, assuming a salvage value of $9,000 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 2.20 times what he paid for it.

   

Sell the property. A realty company has offered to purchase the property by paying $203,000 immediately and $24,000 per year for the next 16 years. Control of the property would go to the realty company immediately. To sell the property, Professor Laski would need to pay the mortgage off, which could be done by making a lump-sum payment of $85,000. Professor Laski requires a 12% rate of return. (Ignore income taxes.)

  
Click here to view Exhibit 11B-1 and Exhibit 11B-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. (Use the appropriate table to determine the discount factor(s) and round final answers to the nearest dollar amount.)

   

b.	Calculate the net present value of cash flows using total cost approach if he sells the property. (Use the appropriate table to determine the discount factor(s) and round final answers to the nearest dollar amount.)

  

c.

Would you recommend Professor Laski to keep the property or to sell?

	Keep the property
	Sell the property

Answer 1

	ALTERNATIVE 1		KEEP THE PROPERTY
			Net operating income	$40,900
			Depreciation of building	$19,000
			Annual cash flow	$59,900
			Number of years	16
			Discount rate	12%	(Required rate of return)
		A	Present value of cash inflow	$417,742	(Using PV function with Rate=12%,Nper=16,Pmt=-59900)
			Annual Mortgage payment	($13,500)
			Number of years	9
		B	Present Value of cashflow	($71,931.37)	(Using PV function with Rate=12%,Nper=9,Pmt=$13500)
			Terminal Cash flow:
			Salvage value of building	$9,000
			Value of land	$        143,000	(65000*2.2)
			Total Cash flow	$152,000
		C	Present Value of terminal cash flow	$          24,794	(152000/(1.12^16)
		D=A+B+C	Net Present value of cash flow	$370,605
	ALTERNATIVE 2		SELL THE PROPERTY
		A	Immediate cash flow	$203,000
		B	Present Value of annual payment of$24000	$167,376	(Using PV function with Rate=12%,Nper=16,Pmt=$24000)
		C	Lumpsum payment for mortgage	($85,000)
		D=A+B+C	Net Present value of cash flow	$285,376
			RECOMMENDATION:
			KEEP THE PROPERTY