Question

Stock valuation Your Aunt Sarah has quite a bit of money. She’s been offered a share in a partnership that is being set up by a local real estate agent. The partnership will buy an existing building, called the Station Building, for $20 million. The agent is selling 25 shares, for $800,000 each. Aunt Sarah has asked you to do some financial analysis to determine whether this is a fair parice for a partnership share in the Station Building. Here’s what you discover: • All income from Station Building partnership will flow through to the shareholders, who will pay taxes on the income at their personal tax rates. Aunt Sarah’s tax rate is 40%. • Station Building will be depreciated over 40 years, giving an annual depreciation of $500,000. • The building is fully rented out and brings in annual rents of $7 million. You do not anticipate that these rents will increase over the next 10 years. • Maintenance, property taxes, and other miscellaneous expenses for Station Building cost about $1 million per year. • The agent who is putting together this partnership has proposed selling Station Building after ten years. He estimates that the market price of the building will not change much over this period and is likely to sell for $20 million. Should Aunt Sarah buy a share in this partnership?

Answer 1

First, Let us take a look at the details of the project

To undestand the financial outcome, Let us do a simple cash flow analysis.

The big assumption here is that my Cost of capital is 10% (Since CoC has not been mentioned above, I assumed it)

So at a CoC of 10%, the Investment looks very favorable.

But let us see what is the limit of the CoC for a favorable investment

At a CoC of 21%, the investment will turn unfavourable