Question

You're advising a client who's considering purchasing land that you project would yield a net revenue of $300,000 immediately after purchase and $250,000 in 10 years and continuing every 10 years in perpetuity. Using the landowner's desired real ARR of 5% what would you recommend as her maximum bid to purchase this property now?

Answer 1

The desired ARR is 5%, average annual profit is $25,000 ($250,000/10) (no expenses subtracted because none given in question)

Therefore, the initial investment should be:

= ($25,000)/(5%)

Which comes to $500,000.

However, this won't be the maximum bid price, as there is also a one-time immediate revenue of $300,000 to be earned.

Ans. We can simply add that to the initial investment calculated before ($500,000), giving us a maximum bid value of $800,000.

We can exclude $300,000 from this bid value when calculating initial investment because we will earn that same amount back immediately after purchase.