Question

You have the opportunity to invest in a small seaside resort with a good track record and a remaining service life of 20 years. The room rental income is estimated to be $500,000 per year for the first five years. Then the rental income will increase by 10% for every five-year interval over the remaining service life of this asset. The estimate for your operating expenses, including taxes, will be $200,000 the first year, and then they will increase by $10,000 each year thereafter. The real estate agency tells you that razing the resort and selling the lot after 20 years will net you $80,000. If you could invest your money for a guaranteed 9% per year for the next 20 years, what would be the maximum amount you would be willing to pay for acquiring this resort?

Answer 1

i=9%

t = 20 yrs

revenue = 500000 constant fr five year then jumps every 5 years for 10%

cost = 200000 increasing by 10000 every yr

salvage = 80000 after 20 yr

Revenue from EOY 6 to EOY 10 = 1.1*500000 = 550000

Revenue from EOY11 to EOY 15 = 1.1*550000 = 605000

Revenue from EOY 16 to EOY 20 = 1.1*605000 = 665500

NPW of future cash flows = 500000*(P/A,9%,5) + 550000*(P/A,9%,5)*(P/F,9%,5) + 605000*(P/A,9%,5)*(P/F,9%,10) + 665500*(P/A,9%,5)*(P/F,9%,15) - 200000*(P/A,9%,20) - 10000*(P/G,9%,20) + 80000*(P/F,9%,20)

= 500000*3.889651 + 550000*3.889651*0.649931 + 605000*3.889651*0.422410 + 665500*3.889651*0.274538 - 200000*9.128545 - 10000*61.77697 + 80000*0.178430

= 2610714.28

Maximum we pay now is 2610714