Question

A company has purchased a lot of beach front property in Miami, Florida but is now worried about the risk of hurricanes from climate change. The company wants to sell the property for the NPV of the future income potential. They 3 scenarios: Scenario #1 - Over the next 5 years (Yr. 1-5), there are no hurricanes and they make $8,000,000 per year. Scenario #2: Over the next 5 years, there are 2 hurricanes that cause minor disruption in their business. They assume those hurricanes occur in years 2 and 4 and for both years, the company makes $1,000,000 below their previous projection. Scenario #3: Over the next 5 years, their property is destroyed by heavy hurricane damage in year 3 eliminating 30% of their profit in years 3-5. If the company wants to make 8% return over the 5 years, how much should they sell their property for today if each scenario is equally likely?

Answer 1

Scenario #1:

The company makes 8,000,000 per year over the 5 years

NPV of the future Income Potential = 8,000,000 * PV annuity factor for 5 years at 8%

= 8,000,000 * 3.99 = $ 32,000,000

The Company should sell their property for $ 32,000,000

Scenario #2:

The company expects that in year 2 & 4, the company makes only 7,000,000 in both the years.

NPV of the future Income Potential:

Year	Amount of cash flows	8 % Factor	PV of cash flows in $
1	8000000	0.926	7408000
2	7000000	0.857	5999000
3	8000000	0.794	6352000
4	7000000	0.735	5145000
5	8000000	0.681	5448000
The Company should sell their property now at	30352000

Scenario #3:

The Company Expects that in year 3-5, the company will loose 30% of profit. That is they will get only $ 5,600,000

Year	Amount of cash flows	8 % Factor	PV of cash flows in $
1	8000000	0.926	7408000
2	8000000	0.857	6856000
3	5600000	0.794	4446400
4	5600000	0.735	4116000
5	5600000	0.681	3813600
The Company should sell their property now at	26640000