Q) A landlord wants an advice on how she might decide whether or not to add...

Q) A landlord wants an advice on how she might decide whether or not to add additional bathroom. The cost of the additional is $10,000. The interest rate is 5% . she can expect to get an additional $ 450 per annum on rent as a result for the life of the bathroom.

She should do the investment?
If the additional rents were $440, should she do the investment?
What would be the position if the interest rate were 4%?

PLEASE GIVE YOUR ANSWER IN WORD FORMAT. DO NOT CONVERT INTO IMAGE.

Expert Solution

(a)
Cost of investment   10000
Additional rent or cash flows   450
Interest rate   5%
Time not given. so assume perpetual

Present value of perpetual payments = cash flows / Interest rate
450/5%
9000

NPV = Present value of cash flows - Present value of cash inflows
9000-10000
-1000

NPV is -$1000. so investment should not be made.

(b)
additional rent or free cash flows
Present value of free cash flows = 440/5%
8800

NPV = 8800-10000
-1200

NPV is -$1200. So investment should not be made.

(c)
If interest rate = 4%
1st case
Present value of free cash flow of $450 = 450/4%
11250

NPV = 11250 - 10000
1250

NPV is 1,250. So investment should be made.

2nd case
Present value of free cash flow of $440 = 440/4%
11000

NPV = 11000 - 10000
1000

NPV is 1,000. So investment should be made.

jeff jeffy answered 2 years ago

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