Question

You are interested in investing in a building costing £500,000 for a period of three years. You can either rent out the building as is (Option A) or install an assortment of energy-efficient fittings at an additional cost of £20,000 (Option B). Regardless of the option chosen, assume that a tenant takes immediate occupation, paying an annual rent in arrears. Maintenance expenses and the sale of the building also take place at the end of the year.

	Option A	Option B
Rent income	£5,000	£5,200
Maintenance expenses	£1,500	£1,400
Discount rate	12%	11%
Selling price	£600,000	£620,000

Based on the above information, and rounding up calculated amounts to the nearest pound, which of the following statements is true?

Answer 1

Given,

Particulars of Cash Flow
	Option A	Option B	Remarks
Year 0 (Investment)	-500000	-520000
Annual Rent (Y1-Y3)	60000	62400	Assuming given figures are for month
Less: Maintenance	18000	16800
Net Cash Inflow (Y1-Y3)	42000	45600
Year 3 (Sale)	600000	620000

Calculation of NPV
	Option A		Option B
Year	Cash Flow	PV @12%	Discounted Cash Flow ($)		Cash Flow	PV @11%	Discounted Cash Flow ($)
Y0	(500,000.00)	1.00	(500,000.00)		(520,000.00)	1.00	(520,000.00)
Y1	42,000.00	0.89	37,500.00		45,600.00	0.90	41,081.08
Y2	42,000.00	0.80	33,482.14		45,600.00	0.80	36,679.54
Y3	42,000.00	0.71	29,894.77		45,600.00	0.72	32,749.59
Y3	600,000.00	0.71	427,068.00		620,000.00	0.72	445,279.66
	NPV		27,944.91				35,789.86

Since Option B has higher NPV .i.e., higher net cash inflow, it is advisable to go with Option B