Question

You are the financial manager for a healthcare organization that is considering the purchase of a building costing $3,000,000. The resale value would be $4,000,000 in 5 years when the organization expects to move into a wing of a new hospital that is being built. You will consider the financial impact of several scenarios.

The owners of the organization are concerned about the following:

1. The business needs to decide whether the future value of the projected purchase outweighs the interest they could earn on a CD that matures in 5 years.
2. What happens if they earn some rent on part of the building?

You will make a recommendation to the company as to whether they should purchase the building now and whether they should seek a tenant for some of the offices.

1. If the interest rate is 8%, what is the present value of the sales price?
2. Is the property investment attractive to you?
3. (1) What is the present value of the future cash flows, if you also could earn $300,000 per year rent on the property? The rent is paid at the end of each year.

(2) Is the property investment attractive to you now?

4. Alternatively, the organization has a choice of remaining in the building it is in now and investing the money in a Certificate of Deposit at one of two different banks. First National Bank pays 4.2% interest compounded semiannually. Second National Bank pays 4% interest compounded monthly. First you will need to calculate the annual rate for both banks and then determine the future value of the CDs.

In your presentation, be sure to highlight how you considered the time value of money as one of your considerations. If your calculations are contradictory, discuss how you came to your decision. Explain whether there are any other issues you would consider.

Answer 1

Part 1

In this part question asks you to Evaluate the propsal of buying the new Building at $3,000,000, which will be sol for $4,000,000 after 5 years.

a) Rate 8%, What is the present value of Sales price.

Ans: Given Sales price is at Time 5 and you need to bring back today.i.e. you need to do discounting and calculate the Present vallue of Property today. Using TVM concept, PV of Sales price is

= =Denominator can be solve as 1.08x1.08x1.08x1.08x1.08 = 1.4693

= 4000000 / 1.4693

= $2,722,384.81

b) Is Property Investment attractive?

Ans. No, Investment in property is not attarctive at all as Present value of Sales price $2,722,384.81 is very less than our Investment of $4,000,000.

c) Present Value of Cash Flows i.e. rental incomce $300000 per Year

Ans: You need to discount the Annual rentak income and bring it today's value. It cane be done with follwing Equation:

= $1,197,813.01

d) Is property Investment Attarctive to you now?

Total benefit from Sales Price and Rental Incomce = $2,722,384.81 + $1,197,813.01

= $3,920,197.82

Th property still not attarctive as it will not recver even the investment amount of $4 Million.

Part B

Option to deposit in CD

Effective rate is the single annual rate on which compunding effect is already given and you can apply direct to get the final figure on annual basis. Like different investment have different compunding periods but after calculating effective rate you can apply directly to amount and comparability becomes easy.

Calculation of Effective rate, and firmula for effective rate is {(1+r)ⁿ -1}x100

a) First National Bank 4.2% compund Semi annually( for semi annual periods are 2, and rate =4.2/2=2.1)

= {(1.021)² -1 } x 100

= 4.2441 %

Future Value = 4000000 x 1.042441 = 4,169,764.

b) Second National Bank pays 4% interest compounded monthly For monthly periods = 12, rate = 4/12= 0.3333%

= {(1.003333)¹²-1} 100

= 4.07374%

Furure Value=4000000 x 1.0407374 = 4,162,949.6