Question

The last investment option for BIC is a heavily depreciated building on 10 acres of land....

The last investment option for BIC is a heavily depreciated building on 10 acres of land. The NOI next year is expected to be $100,000. However, because real depreciation is expected to increase, BIC expects cash flows to decline at the rate of 1% per year indefinitely. BIC desires to earn a rate of 9.25%.

A) What is the value of the property?

Assume that at the end of year 5 the building will be demolished and the land can be redeveloped with a strip retail development. The new property will cost $1,000,000 at that time (year 5) to development and the NOI is $200,000 starting at the end of year 6 and subsequently grows 1.5% per year. Investors currently earn a rate of 10% on such investments. Also, since the new building will be built in 5 years, assume that the real depreciation noted in part A is not included in this scenario.

B) What is the new value of the depreciated building and land?

C) Should they purchase the property if the final negotiated price is $1,000,000?

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Answer #1

Ans a) Net operating income for next year = $100000 ( includes decline in cash flows indefinite as net operating income on propoerty is calculated by cash inflow - all the expenses paid)

Desired rate of return = 9.25%

Value of property = Net operating income/ desired rate of return

= 100000/0.0925 = $10,81,081.08

Ans b) Value of land can be calculated as value of highly depreciated property at the end of year 5.

since every year cash flows will decline by 1%, Net operating income will also decrese by 1%. Next Year net operating income given is $100000.

Net operating income in year 5 will be = $96060

Value of the land = 96060/0.10 = $ 9,60,600

Value of the new property = 200000/0.10 = $20,00,000

Ans c) They should purchased the property as value of property is more than negotiated price.

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