Your firm is considering purchasing an old office building with an estimated remaining service life of 25 years. Recently, the tenants signed a longterm lease, which leads you to believe that the current rental income of $250,000 per year will remain constant for the first five years. Then the rental income will increase by 10% for every five-year interval over the remaining life of the asset. That is, the annual rental income would be $275,000 for years 6 through 10, $302,500 for years 11 through 15, $332,750 for years 16 through 20, and $366,025 for years 21 through 25. You estimate that operating expenses, including income taxes, will be $85,000 for the first year and that they will increase by $5,000 each year thereafter. You also estimate that razing the building and selling the lot on which it stands will realize a net amount of $50,000 at the end of the 25-year period. If you had the opportunity to invest your money elsewhere and thereby earn interest at the rate of 12% per annum, what would be the maximum amount you would be willing to pay for the building and lot at the present time?

Practical Management Science
6th Edition
ISBN:9781337406659
Author:WINSTON, Wayne L.
Publisher:WINSTON, Wayne L.
Chapter2: Introduction To Spreadsheet Modeling
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Your firm is considering purchasing an old
office building with an estimated remaining service
life of 25 years. Recently, the tenants signed a longterm lease, which leads you to believe that the current
rental income of $250,000 per year will remain constant for the first five years. Then the rental income
will increase by 10% for every five-year interval over
the remaining life of the asset. That is, the annual
rental income would be $275,000 for years 6 through
10, $302,500 for years 11 through 15, $332,750 for
years 16 through 20, and $366,025 for years 21
through 25. You estimate that operating expenses,
including income taxes, will be $85,000 for the first
year and that they will increase by $5,000 each year
thereafter. You also estimate that razing the building
and selling the lot on which it stands will realize a net
amount of $50,000 at the end of the 25-year period.
If you had the opportunity to invest your money elsewhere and thereby earn interest at the rate of 12% per
annum, what would be the maximum amount you
would be willing to pay for the building and lot at
the present time?

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