Question

In: Finance

Your company's regional offices are located in Vancouver in a building rented for $850,000 per year...

Your company's regional offices are located in Vancouver in a building rented for $850,000 per year (payable at the end of each year). The building is for sale for $ Y. The local branch of the Royal Bank is willing to provide a mortgage of $2,800,000 toward the purchase of the building. The duration of the mortgage is 20 years, at a yearly interest rate of 4%. The mortgage will have to be repaid by 20 equal yearly (end of year) payments of $X each. (These payments would cover both interest and principal, so that after the last payment the mortgage is fully discharged).

Your company requires the building for ten years. The estimated value of the building at the end of 10 years is $3,400,000, and the mortgage principal outstanding at that time is $P. The* yearly cost of owning the building (municipal tax, maintenance, etc.) is $300,000. MARR (the minimum attractive rate of return) for your company is 12%.

Determine:

(a)        the mortgage payments, x        (3 mark)

(b)        the mortgage principal owing at the end of 10 years, P        (3 madß)

(c)        the total amount of mortgage interest in the first ten years (d) the internal rate of return of this purchase (for your company) if Y =3,550,000 (10 marls)

(e) the maximum value of Y which would be (economically) acceptable for your company

Solutions

Expert Solution

(a) The annual payment formula = Loan * [r * (1+r)t]/[(1+r)t - 1] ; where r is the annual rate (4%) and t is the term of loan (20 years)

Hence we have annual payment = 2800000 * [4% * (1+4%)20] / [(1+4%)20 - 1] = 206,028.90

(b) Residual Loan Balance after k years is given by formula = Loan * [(1+r)t - (1+r)k]/[(1+r)t - 1] ; plugging the values or r, t and k (10 )

Residual Loan = 2800000 * [(1+4%)20 - (1+4%)10] / [(1+4%)20 - 1] = 1,671,078.94

(c) Total Mortgage Interest in first 10 years = Annual Payment * 10 - Principal Repaid in 10 years = 10 * 206028.90 - (2800000 - 1671078.94) = 931,367.95

(d) IRR worksheet is as below

Hence we see that the IRR is 47.18% which is significantly higher than 12% MARR.

(e) The company would find it profitable to purchase the property till such time the IRR is atleast 12% which is to say that the NPV at 12% discount rate should be zero for that value of Y. Since the sum of present value of positive CF from Year 1 to 10 (discounted at 12%) is 2500179.74, hence for the NPV to be zero, the difference between the loan amount and property value should maximum be 2500179.74. Hence the maximum acceptable value of Y = 2500179.74 + 2800000 = 5,300,179.74


Related Solutions

A&A, CPAs, is a regional firm with 20 offices located in large cities throughout the Midwestern...
A&A, CPAs, is a regional firm with 20 offices located in large cities throughout the Midwestern United States. You have worked as an audit senior in A&A, CPAs for three years and have mastered your job. Your manager is impressed by your performance and ask you to assist in making a decision on whether to accept a re-audit for a well-respected regional company, B. You just left a meeting with B Company. You were asked whether your firm would be...
Rayburn Corporation has a building that it bought during year 0 for $850,000. It sold the building in year 5.
Rayburn Corporation has a building that it bought during year 0 for $850,000. It sold the building in year 5. During the time it held the building Rayburn depreciated it by $100,000. What is the amount and character of the gain or loss Rayburn will recognize on the sale in each of the following alternative situations? (Loss amounts should be indicated by a minus sign. Enter NA if a situation is not applicable. Leave no answer blank. Enter zero if...
An office building in your community has fifty offices, each with an average of four desks....
An office building in your community has fifty offices, each with an average of four desks. Each desk has a desk lamp that can use either a 60 watt incandescent bulb or a 13 watt fluorescent unit. The average use of a lamp is seven hours per day. How much power is required for the building per year for each of the two options? Given your local energy cost, what is the annual cost of each of the two options?...
Machine A costs $850,000 and would produce cash flows of $220,000 per year for the first...
Machine A costs $850,000 and would produce cash flows of $220,000 per year for the first two years, $350,000 per year for the next two years, and $150,000 in the final year. Machine B costs $650,000 and would produce cash flows of $250,000 per year for the first two years, $200,000 the following year, $150,000 in its fourth year, and $140,000 in its final year. Your required return is 11%. What is the IRR of buying machine B?
One of your company's essential suppliers is located in Japan. Your company needs to make a...
One of your company's essential suppliers is located in Japan. Your company needs to make a 1 million Japanese yen payment in six months. Considering that your company primarily operates in U.S. dollars, you are assigned the task of deciding on a strategy to minimize your transactions exposure. Identify the spot and forward exchange rates between the two currencies. What factors influence your decision to use each? Which one would you choose? How many dollars must you spend to acquire...
Conference Services Inc. has leased a large office building for $4 million per year. The building...
Conference Services Inc. has leased a large office building for $4 million per year. The building is larger than the company needs: two of the building's eight stories are almost empty. A manager wants to expand one of her projects, but this will require using one of the empty floors. In calculating the net present vlaue of the proposed expansion, upper management allocates one-eighth of $4 million of building rental costs (i.e., $.5 million) to the project expansion, reasoning that...
A company's 5-year bonds are yielding 7.85% per year. Treasury bonds with the same maturity are...
A company's 5-year bonds are yielding 7.85% per year. Treasury bonds with the same maturity are yielding 5.9% per year, and the real risk-free rate (r*) is 2.45%. The average inflation premium is 3.05%, and the maturity risk premium is estimated to be 0.1 x (t - 1)%, where t = number of years to maturity. If the liquidity premium is 1.05%, what is the default risk premium on the corporate bonds? Round your answer to two decimal places.
A company's 5-year bonds are yielding 9% per year. Treasury bonds with the same maturity are...
A company's 5-year bonds are yielding 9% per year. Treasury bonds with the same maturity are yielding 4.7% per year, and the real risk-free rate (r*) is 2.85%. The average inflation premium is 1.45%, and the maturity risk premium is estimated to be 0.1 × (t - 1)%, where t = number of years to maturity. If the liquidity premium is 0.9%, what is the default risk premium on the corporate bonds? Round your answer to two decimal places.
calculate the company's value per share using the Residual Earnings approach. In the current year (Year...
calculate the company's value per share using the Residual Earnings approach. In the current year (Year 0), the company reported EPS of $6 Earnings are expected to grow at 6% per year for the next 5 years and Residual Earnings are expected to grow at 3% beyond that. Dividends per share are typically 20% of EPS Book Value per share at Year 0 is $25 The company's Required Rate of Return is 9%
In its first year of operations, your company's income tax expense was $40,000, and your year-end...
In its first year of operations, your company's income tax expense was $40,000, and your year-end income taxes payable came to $40,000. Explain what happened here.
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT