Question

You have the opportunity to invest in a small seaside resort with a good track record and a remaining service life of 20 years. The room rental income is estimated to be $500,000 per year for the first five years. Then the rental income will increase by 10% for every five-year interval over the remaining service life of this asset. The estimate for your operating expenses, including taxes, will be $200,000 the first year, and then they will increase by $10,000 each year thereafter. The real estate agency tells you that razing the resort and selling the lot after 20 years will net you $80,000. If you could invest your money for a guaranteed 9% per year for the next 20 years, what would be the maximum amount you would be willing to pay for acquiring this resort?

Answer 1

If we see here in this problem we need to find the net inflow which will be = rental income - operating expense

and as the questions says that operating exp increases by $ 10000 per year I have taken that into consideration

also rental income will increase by 10% after 5 year with a term of 5 years,

Since the opportunity cost of investing money is 9% so in order to calculate the NPV i had taken rate of interest as 9%

NPV = Net inflow/(1+rate)^year

All amount are in $

Year	Rental Income Inflow	Operating Expense	Net Inflow	Selling of resort after 20 years	Net Inflow	Net Present Value
1	500000	200000	300000		300000	275229.4
2	500000	210000	290000		290000	244087.2
3	500000	220000	280000		280000	216211.4
4	500000	230000	270000		270000	191274.8
5	500000	240000	260000		260000	168982.2
6	550000	250000	300000		300000	178880.2
7	550000	260000	290000		290000	158639.9
8	550000	270000	280000		280000	140522.6
9	550000	280000	270000		270000	124315.5
10	550000	290000	260000		260000	109826.8
11	605000	300000	305000		305000	118197.5
12	605000	310000	295000		295000	104882.7
13	605000	320000	285000		285000	92960.91
14	605000	330000	275000		275000	82292.78
15	605000	340000	265000		265000	72752.58
16	665500	350000	315500		315500	79464.91
17	665500	360000	305500		305500	70592.86
18	665500	370000	295500		295500	62644.15
19	665500	380000	285500		285500	55526.8
20	665500	390000	275500	80000	355500	63432.18
					=sum	2610717

Thus we see the NPV of the total inflow is $26,10,717. Thus this would be the maximum amount a person should be willing to spent to acquire the resort