Question

Raul Martinas, a professor of languages at Eastern University, owns a small office building adjacent to the university campus. He acquired the property 10 years ago at a total cost of $530,000—that is, $50,000 for the land and $480,000 for the building. He has just received an offer from a realty company that wants to purchase the property; however, the property has been a good source of income over the years, and so Martinas is unsure whether he should keep it or sell it. His alternatives are as follows:

a.

Keep the property. Martinas’s accountant has kept careful records of the income realized from the property over the past 10 years. These records indicate the following annual revenues and expenses: Professor Martinas makes a $12,000 mortgage payment each year on the property. The mortgage will be paid off in eight more years. He has been depreciating the building by the straight-line method, assuming a salvage value of $80,000 for the building, which he still thinks is an appropriate figure. He feels sure that the building can be rented for another 15 years. He also feels sure that 15 years from now the land will be worth three times what he paid for it.

Rental receipts				$	140,000
Less: Building expenses:
Utilities	$	25,000
Depreciation of building		16,000
Property taxes and insurance		18,000
Repairs and maintenance		9,000
Custodial help and supplies		40,000			108,000
Net operating income				$	32,000

b.

Sell the property. A realty company has offered to purchase the property by paying $175,000 immediately and $26,500 per year for the next 15 years. Control of the property would go to the realty company immediately. To sell the property, Professor Martinas would need to pay the mortgage off, which could be done by making a lump-sum payment of $90,000.

  

Click here to view Exhibit 10-1 and Exhibit 10-2, to determine the appropriate discount factor(s) using tables.

  

Required:

Assume that Professor Martinas requires a 12% rate of return. Compute net present value in favor of (or against) keeping the property using the total-cost approach. (Round discount factor(s) to 3 decimal places and other intermediate calculations to the nearest dollar amount.)

Would you recommend that he keep or sell the property?

Keep the property Sell the property

Answer 1

for formulas and calculations, refer to the image below -

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