Question

Suppose that you own a building that does not generate enough rental revenue to cover the maintenance cost. You have two options: First, you could demolish the building and set up a parking lot; second you could abandon the building. Suppose that the cost of demolition is $20,000 and the annual profit from the parking lot would be $1,500. Should you demolish or abandon? If you don’t have enough information to answer the question, list the information you need and explain how you would use it.

Answer 1

Information is inadequate.

The decision to demolish and set up a parking lot requires that the present value of costs related to the decisions be less than the present value of benefits. Calculation of the present values will require following information:

(1) Cost (investment) required to set up the parking lot (I0),

(2) Number of years that the parking lot be expected to be in use (N), and

(3) Annual discount rate (r).

With these information, the demolition will be carried out only if

$1,500 x P/A(r%, N) > ($20,000 + I0).