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.)

Answer 1

Keeping the Property

Particulars	Year 0 - 10	Year 11 -16	Total
Net Operating Income per annum	44,400	44,400
Add: Depreciation (Non Cash)	19,700	19,700
Less: Loan Repayment	-14,200	Nil
Net Cash Inflow	49,900	64,100
Present Value Annuity Factor @ 12% (0.287+0.257+0.229+0.205+0.183+0.163 = 1.324) for 11 to 16th year	5.65	1.324
Present Value of Cash Inflows	281,935	84,868	366,803
Present Value of Salvage Value of Building after 24 years {($721,000- $ 9,700)} depreciation of $ 19,700 with Present Value Factor at 12% for34 years - 10 years already passed = 0.066	$ 9,700 x 0.066	640
Total Net Present Value of Option I	367,443

In this case, the appreciation in value of land is an additional benefit to Ryatt.

kindly upvote