Question

Property type	Price	Mortgage	Expected		Estimated
			Rental income	Depreciation expense	resale
			(per year)	(per year)	value
Strip shopping center	$800,000	$448,000	$136,016	$7,692	$912,000
Small apartment complex	$650,000	$292,500	$91,281	$8,273	$685,100

The first potential investment consists of a seven-store shopping center, which has a current market price of $800,000. Of this amount, $200,000 represents the cost of the land, and the balance, $600,000, is attributable to buildings on the property. The second possible investment, which costs $650,000, consists of a small four-unit apartment complex. $195,000 of the investment's total price is reflects the cost of land, and the remaining $455,000 is associated with structures on the land. For both properties, you believe you can increase the rents 2% per year for each of the next four years, and expect to sell either property at the end that time. You desire a return of 7% on your investments.

Assume that your expected annual operating costs—excluding your annual depreciation expense—for the commercial property will be 35% of your annual rental income. For the residential property, the annual operating costs (excluding depreciation expense) will be 20% of your annual rental income. The interest rates of the mortgages for the commercial and residential lease properties are expected to be 6% and 4%, respectively.

Given your other assumptions, complete the following two tables and then use your computations to answer several questions. Round all amounts to the nearest whole dollar. (Hint: Don’t round intermediate calculations. Also, don’t forget that capital gains are taxed at 15% if properties are sold for more than their original purchase price.)

Strip shopping center	Year 1	Year 2	Year 3	Year 4
Annual rental income
Estimated resale value	0	0	0
Less: Annual operating expenses
Less: Annual depreciation expense
Less: Annual interest payments (6%)	26,880	25,536	24,192	22,848
Less: Taxes (25%)
Less: Capital gains tax (15%)	0	0	0
Net profit
Interest factor (7%)	0.9346	0.8734	0.8163	0.7629
PV of Cash flow
Total PV of Cash flows

The net discounted return expected from an investment in the shopping center—after deducting the cost of the investment—is ( $30,991, $830,991, $55784, $24,793) .

Answer 1

Step 1: Calculation of Present Value of Cash Inflows for Shopping Center:

Particulars	Year 1	Year 2	Year 3	Year 4
Annual rental income	138,736	141,511	144,341	147228
Estimated resale value	0	0	0	912,000
Less: WDV at Year 4	0	0	0	(769,232)
Less: Annual operating expenses	48,558	49,529	50,519	51,530
Less: Annual depreciation expense	7,692	7,692	7,692	7,692
Less: Annual interest payments (6%)	26,880	25,536	24,192	22,848
Profit Before Tax	55,606	58,754	61,938	65,158
Less: Taxes (25%)	13,902	14,688	15,484	16,290
Less: Capital gains tax (15%) on 142,768	0	0	0	21,415
Net Profit after Tax	41,704	44,066	46,453	27,454
Add: Depreciation	7,692	7,692	7,692	7,692
Cash Flow	49,396	51,758	54,145	947,145
Interest factor (7%)	0.9346	0.8734	0.8163	0.7629
PV of Cash flow	46,166	45,205	44,199	722,577

Step 2: NPV Calculation

NPV = 858,147 - 800,000

NPV or Net discounted Return = 58,147