Question

Use the following information to evaluate this investment assuming below-line treatment of capital expenditures: property: 5 office units, contract rents per unit: $2,500 per month; vacancy and collection losses: 14%; operating expenses: $42,000; capital expenditures: 5%. After 5 years this property will be sold for $750,000. The cost of capital is 11%, and the capitalization rate is 9%. The property is currently valued at $1,000,000. Use all the methods from this class to decide whether to purchase this property.

Answer 1

		$
	Rent revenue ( $ 2,500 per month x 12 months x 5 office units )	150,000
	Less: vacancy and collection losses ( $ 150,000 x 14% )	(21,000)
	Less: Operating expenses	(42,000)
	Less: Capital expenditure ( $ 150,000 x 5 % )	(7,500)
	Net cash inflow per annuam	79,500
	Computation of net present value
Year	Cash flow	Amount $	Present Value at 11%	Discounted cash flow $
0	Investment in property ( current value )	(1,000,000)	1	(1,000,000)
1	Annual cash inflow	79,500	0.9009	71,622
2	Annual cash inflow	79,500	0.8116	64,524
3	Annual cash inflow	79,500	0.7312	58,130
4	Annual cash inflow	79,500	0.6587	52,369
5	Annual cash inflow	79,500	0.5935	47,179
5	Resale value of property after 5 years	750,000	0.5935	445,088
	Net Present Value ( NPV )			(261,088)
	Investment in property is not finacially viable since the NPV is negative. Therefore, it is not to be invested in this property.