Question

A fund purchased an office block nine months ago for RM5 million. It will spend a further RM900,000 on refurbishment in two months’ time.

A company has agreed to occupy the office block six months from now. The lease agreement states that the company will rent the office block for fifteen years and will then purchase the property at the end of the fifteen year rental period for RM6 million. It is further agreed that rents will be paid at the beginning of each quarter and will be increased every three years at the rate of 4% per annum. The initial rent has been set at RM200,000 per quarter with the first rental payment due immediately on the date of occupation.

Calculate, as at the date of purchase of the office block, the net present value of the project to the fund assuming an effective rate of interest of 8% per annum.

Answer 1

The net present value is the discounted cash flow methid that considers time value of money in evaluating capital investments.

Initial Cash Outflow

Cost of the project = RM 500,000

Refurbishment Cost = RM 900,000

TOTAL CASH OUTFLOW = RM 1400,000

STATEMENT SHOWING ANNUAL CASH FLOWS

YEAR	QUARTERLY CASH FLOWS	ANNUAL CASH FLOWS
1	200000	600000
2	200000	600000
3	200000	600000
4	200000 + 4 %	624000
5	208000	624000
6	208000	624000
7	208000 + 4%	648960
8	216320	648960
9	216320	648960
10	216320 + 4 %	674918
11	224973	674918
12	224973	674918
13	2249738+ 4%	701915
14	233972	701915
15	233972	701915
	TOTAL	9749650

STATEMENT SHOWING DISCOUNTED CASH FLOWS

YEAR	CASH FLOWS	DISCOUNTING FACTOR @ 8 %	PRESENT VALUE
1	600000	(1/1.08) =.925	555000
2	600000	.857	514200
3	600000	.793	475800
4	624000	.735	458640
5	624000	.680	424320
6	624000	.630	393120
7	648960	.583	378344
8	648960	.540	350438
9	648960	.500	324480
10	674918	.463	312487
11	674918	.428	288865
12	674918	.397	267942
13	701915	.367	257603
14	701915	.340	238651
15	701915	.315	221103

TOTAL DISCOUNTED CASH FLOWS = RM 5460993

NET PRESENT VALUE = INITIAL CASH OUTFLOW - SUM OF DISCOUNTED CASH FLOWS

= RM 1400000 - RM 5460993

= - ( 4060993)