Question

Suppose you want to buy an apartment building. The apartment building will generate a rental income of $6,000 at the end of each month for the next 25 years. However, $10,000 has to be incurred each year to maintain the building. The maintenance costs are paid at year-end. Interest rates will remain constant at 10 percent compounded annually.

REQUIRED:

What is the maximum price you should pay for the building?`

Answer 1

In this question we have been provided with the amount of income as well as expense which we will incur while purchasing an asset, which if apartment building in this case.

thus, to calculate the maximum price which we should pay for the building, we need to find its present value of both income and expense, and afterwards expense shall be deducted from the income to find the maximum value which we shall pay for the building.

CASH INFLOW FROM BLDG.	$6000 PER MONTH	thus,$ 6000*12= $72000 per YEAR
CASH OUTFLOW FROM BLDG.	$10,000 per YEAR
formula to find present value (pv)
pv= cashflow/(1+r)n
TOTAL CASH INFLOW	$72000*25YEARS   =	$1750000
r	10%
n	25yrs
Putting eveything in formula-
1750000/1.1 25	$161517.996
TOTAL CASH OUTFLOW	$10000*25            =	250000
r	10%
n	25yrs
Putting everything in formula-
250000/1.1 25	$23074

Thus, we now have pv of cashinflow and outflow

now,

$161517.996 - $23074 = $138443.996

hence, maximum amount payable for the building apartment shall be $138443.996