Your firm is considering purchasing an old office building with an estimated remaining service life of 25 years. Recently, the tenants signed a long-term 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?
Your firm is considering purchasing an old office building with an estimated remaining service life
of 25 years. Recently, the tenants signed a long-term 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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