A real-estate investor has the opportunity to purchase a small apartment complex. The apartment complex costs $4 million and is expected to generate net revenue (net after all operating and finance costs) of $60,000 per month. Of course, the revenue could vary because the occupancy rate is uncertain. Considering the uncertainty, the revenue could vary from a low of − $10,000 to a high of $100,000 per month. Assume that the investor’ s objective is to maximize the value of the investment at the end of 10 years. a) Do you think the investor should buy the apartment complex or invest the $4 million in a 10-year certificate of deposit earning 9.5%? Why? b)b) The city council is currently considering an application to
Q1. A real-estate investor has the opportunity to purchase a small apartment complex. The apartment complex costs $4 million and is expected to generate net revenue (net after all operating and finance costs) of $60,000 per month. Of course, the revenue could vary because the occupancy rate is uncertain. Considering the uncertainty, the revenue could vary from a low of − $10,000 to a high of $100,000 per month. Assume that the investor’ s objective is to maximize the value of the investment at the end of 10 years.
a) Do you think the investor should buy the apartment complex or invest the $4 million in a 10-year certificate of deposit earning 9.5%? Why?
b)b) The city council is currently considering an application to rezone a nearby empty parcel of land. The
owner of that land wants to build a small electronics-assembly plant. The proposed plant does not really
conflict with the city’s overall land use plan, but it may have a substantial long-term negative effect on
the value of the nearby residential district in which the apartment complex is located. Because the city
council currently is divided on the issue and will not make a decision until next month, the real estate
investor is thinking about waiting until the city council makes its decision.
If the investor waits, what could happen? What are the tradeoffs that the investor has to make in
deciding whether to wait or to purchase the complex now?
c) Suppose the investor could pay the seller $10,000 in earnest money now, specifying in the purchase
agreement that if the council’ s decision is to approve the rezoning, the investor can forfeit the $10,000
and forego the purchase. Draw and solve a decision tree showing the investor’ s three options. Examine
the alternatives for dominance. If you were the investor, which alternative would you choose? Why?
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