Question

A house is rented with the rental price paid at the end of the first year

of Rp.13,000,000. The rental price in subsequent years decreased by

Rp.500,000 per year for the 15-year economic life of the house. The cost of

building the house is IDR 80,000,000. The cost of building a house is

incurred in year 0 and revenue from rent is received at the end of each

year. Determine the advantages or disadvantages of this scheme if the bank interest rate is

5% per year.

Answer 1

The advantage of Rp 23.29 million exists in the scheme when the bank interest rate is at 5% per year based on the net present value approach as calculated below.

The advantage is due to the higher net present value of the rent to be received over the next 15 years in comparison to the initial outflow of cost of the building.

The rent is higher at the initial year and keeps on decreasing as time progresses. Due to this, the present value of rent in the initial years is higher leading to a higher net present value of the total rent to be received over 15 years as per the scheme

Since the tax rates are not provided, it has been assumed that there is no impact of tax on the scheme.

	Years	1	2	3	4	5	6	7	8	9	10	11	12	13	14	15
	Rent received	13,000,000	12,500,000	12,000,000	11,500,000	11,000,000	10,500,000	10,000,000	9,500,000	9,000,000	8,500,000	8,000,000	7,500,000	7,000,000	6,500,000	6,000,000
5%	Present value factor @5%	0.9524	0.9070	0.8638	0.8227	0.7835	0.7462	0.7107	0.6768	0.6446	0.6139	0.5847	0.5568	0.5303	0.5051	0.4810
	Present value of rent to be received	12,380,952	11,337,868	10,366,051	9,461,078	8,618,788	7,835,262	7,106,813	6,429,974	5,801,480	5,218,263	4,677,434	4,176,281	3,712,249	3,282,942	2,886,103
	Total present value of rent	103,291,539
	Cost of building	80,000,000
	Net benefit (NPV)	23,291,539