Question

1. Suppose that your required rate of return on a duplex is 12 percent. You are shown one such property which has an asking price of $30,000. The sales representative shows you the following cash flow projections for a holding period of 6 years:

Year 1: Year 2: Year 3: Year 4: Year 5: Year 6:

$4,500 $5,000 $6,000 $3,000 $8,000 $20,000

a. Should you buy the investment?

b. What would be your expected rate of return?

2. What is the net present value of the duplex investment in Problem #9 if the asking price is $28,000 and your required rate of return is 12 percent? 10 percent? 15 percent?

Answer 1

1.

a)

As the NPV of the Project is Negative, you should not buy the project.

b) The expected return is the IRR of the project.

Hence, the expected return of the project is 10.92%

2.

Year	Cash Flow	Present Value (Cash Flow/1.12^year)	Present Value (Cash Flow/1.10^year)	Present Value (Cash Flow/1.15^year)
0	(28,000.00)	(28,000.00)	(28,000.00)	(28,000.00)
1	4,500.00	4,017.86	4,090.91	3,913.04
2	5,000.00	3,985.97	4,132.23	3,780.72
3	6,000.00	4,270.68	4,507.89	3,945.10
4	3,000.00	1,906.55	2,049.04	1,715.26
5	8,000.00	4,539.41	4,967.37	3,977.41
6	20,000.00	10,132.62	11,289.48	8,646.55
	NPV (Total)	853.10	3,036.92	(2,021.92)

Hence NPV of the project would be $853.10, $3036.82 and -$2021.91 if the required rate of return would be 12%, 10% and 15% respectively.