Question

A commercial rental property is offered for sale and consists of a two-storey building in the business district of a small city. The building contains two stores on the first floor and a number of offices on the 2nd floor.

A prospective purchaser estimated that if he buys this property, he will hold it for about 10 years. He estimates that the average annual receipts from rentals during this period to be ₱70,000 and the average annual expenses for all purposes in connection with its ownership and operation (maintenance, repairs, janitorial services, etc.) to be ₱27,000. He believes that the property can be sold for a net of ₱400,000 at the end of 10 years. He considers the minimum rate of return on this type of investment to be 10%.

a. On the basis of the above estimates, what price for this property would just permit him to recover his investment with 10% return before taxes?

b. Would you recommend buying the property if the owner offers it for sale for ₱630,000?

Answer 1

Answer:

Annual receipts-Annual expenses=70000-27000=43000.

Present value of annual cashflows=43000(P/A,10%,10)=43000*6.145=264,235

Presesent value of salvage value to be received in year 10=400000(P/F,10%,10)=400000*0.3855=154,200.

Present value of future cashflows from the purchase of building=418,435.

a)

If the price of property is equal to or less than present value of future cashflows, i.e. P418,435, then it can be considered for purchase.

b)

​​​​​​​If the price offered is 630000, then it cannot be purchased because it is higher than the present value of future cash flows.