Question

Consider a Property with expected future NOI of $25,000 per year for the next 5 years (starting one year from now). After that, the operating cash flow will step up 20% to $30,000 for the following 5 years. Assume no capital- and leasing expenses.

(a) If you expect to sell the property 10 years from now at a going-out cap rate of 10%, what is the value of the property if the required return is 12%?

(b) Now suppose the seller of the building wants $260,000. Should you make the deal? Why or why not?

Answer 1

a)

        Value of the propertyV₀ = S 25000/(1.12)^t + S 30000/(1.12)^t + 300000/(1.12)¹⁰

                                                                                           t=1                                        t=6

                        = $248,075

0 --> CF₀,= cash flow at year 0

            25000 --> CF₁, 5 --> N₁, Cash flow from year 1-5

            30000 --> CF₂, 4 --> N₂, Cash flow from year 6-9^th year

            330000 --> CF₃   (Terminal Capitalization +cash flow for 10^th year)

                                            (300000+30000)

            12% --> Interest rate perYear

            NPV --> 248075

Terminal Capitalization of property = Last year net operating income/going out cap rate

= $30000/10% = $300000

Year	Net cash flow	Present value of $1 @12% discount rate	Present value of Net cash flows
0	0		0
1	25000	0.892857143	22321.42857
2	25000	0.797193878	19929.84694
3	25000	0.711780248	17794.5062
4	25000	0.635518078	15887.95196
5	25000	0.567426856	14185.67139
6	30000	0.506631121	15198.93364
7	30000	0.452349215	13570.47646
8	30000	0.403883228	12116.49684
9	30000	0.360610025	10818.30075
10	30000	0.321973237	9659.19711
10	300000	0.321973237	96591.9711
			248074.781

b)No, we won’t accept the deal

From the above the net present value of property is $248074.78 which is less than the sellers quoted price which is 260000.

NPV = $248,075 - $260,000 = - $11,925 < 0