Question

In: Economics

The monthly income from a piece of commercial property is​ $1,500 ​(paid as a lump sum...

The monthly income from a piece of commercial property is​ $1,500 ​(paid as a lump sum at the end of the​ year). Annual expenses are​ $2000 for upkeep of the property and ​$800 for property taxes. The property is surrounded by a security fence that cost​ $4,000 to install four years ago. Assume 52 weeks in a year and​end-of-year cash flows.

a. If i=14​%per year​ (the MARR) is an acceptable interest​ rate, how much could you afford to pay now for this property if it is estimated to have a​ re-sale value of ​$130,000 ten years from​ now?

b. Choose the correct cash flow diagram for this situation. Use the viewpoint of the buyer.

c. Based on this​ situation, give examples of opportunity costs.

d. Based on this​ situation, give examples of fixed costs.

e. Based on this​ situation, give examples of sunk costs.

f. If the 1414​% interest had been a nominal interest​ rate, what would the corresponding effective annual interest rate have been with​ bi-weekly (every two​ weeks) compounding?

Solutions

Expert Solution

a)

Annual Rental income=1500*12=$18000

Annual costs=2000+800=$2800

Net revenue per year=18000-2800=$15200

Expected sale price=FV=$130000

MARR=i=14%

Number of years=n=10 years

Price of property today=PW of cash flows=15200(P/A,14%,10)+130000*(P/F,14%,10)

(P/F,14%,10)=1/(1+14%)^10=0.269744

Price of property today=PW of cash flows=15200*5.216116+130000*0.269744=$114351.68

b)c)

Opportunity cost is the value of the next highest valued alternative of that resource.

i.e. Price of property that can be invested anywhere else for better return, annual income that can be reinvested to earn interest (MARR is the opportunity cost)

d)

Fixed costs are the costs that are independent of usage or production volumes. Property tax, annual maintenance cost are examples of fixed cost in this case.

e)

A sunk cost is the cost that is already incurred and cannot be recovered. Fence cost is a example of sunk cost in this case.

f)

Number of compounding periods=52/2=26 (bi weekly)

Bimonthly interest rate=14%/26=0.5385%

Effective annual rate of interest =(1+0.5385%)^26-1=14.99%

Rahul Sunny answered 2 years ago
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