Assignment Print View 2021-04-08, 1:40 PM

Score: 50/50 Points 100 %

2. Award: 10 out of 10.00 points

Raul Martinas, a professor of languages at Eastern University, owns a small office building adjacent to the
university campus. He acquired the property 10 years ago at a total cost of $563,000—that is, $53,000 for
the land and $510,000 for the building. He has just received an offer from a realty company that wants to
purchase the property; however, the property has been a good source of income over the years, and so
Martinas is unsure whether he should keep it or sell it. His alternatives are as follows:

a. Keep the property. Martinas’s accountant has kept careful records of the income realized from the
property over the past 10 years. These records indicate the following annual revenues and expenses:
Martinas makes a $12,750 mortgage payment each year on the property. The mortgage will be paid off
in eight more years. He has been depreciating the building by the straight-line method, assuming a
salvage value of $76,500 for the building, which he still thinks is an appropriate figure. He feels sure that
the building can be rented for another 15 years. He also feels sure that 15 years from now the land will
be worth three times what he paid for it.

Rental receipts $ 167,000

Less: Building expenses:
Utilities $ 27,150
Depreciation of building 17,340
Property taxes and insurance 20,250
Repairs and maintenance 17,800
Custodial help and supplies 50,000 132,540
Net operating income $ 34,460

b. Sell the property. A realty company has offered to purchase the property by paying $234,000
immediately and $28,250 per year for the next 15 years. Control of the property would go to the realty
company immediately. To sell the property, Martinas would need to pay the mortgage off, which could be
done by making a lump-sum payment of $122,500.

Click here to view Exhibit 10-1 and Exhibit 10-2, to determine the appropriate discount factor(s) using
tables.

Required:
Assume that Martinas requires a 12% rate of return. Compute net present value in favor of (or against)
keeping the property using the total-cost approach. (Round discount factor(s) to 3 decimal places and
other intermediate calculations to the nearest dollar amount.)

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Assignment Print View 2021-04-08, 1:40 PM

Net present value $ 28,654 !

Would you recommend that he keep or sell the property?

Keep the property

References

Worksheet Learning Objective:

10-02 Understand and
apply alternative
methods to analyze
capital investments.

Raul Martinas, a professor of languages at Eastern University, owns a small office building adjacent to the
university campus. He acquired the property 10 years ago at a total cost of $563,000—that is, $53,000 for
the land and $510,000 for the building. He has just received an offer from a realty company that wants to
purchase the property; however, the property has been a good source of income over the years, and so
Martinas is unsure whether he should keep it or sell it. His alternatives are as follows:

a. Keep the property. Martinas’s accountant has kept careful records of the income realized from the
property over the past 10 years. These records indicate the following annual revenues and expenses:
Martinas makes a $12,750 mortgage payment each year on the property. The mortgage will be paid off
in eight more years. He has been depreciating the building by the straight-line method, assuming a
salvage value of $76,500 for the building, which he still thinks is an appropriate figure. He feels sure
that the building can be rented for another 15 years. He also feels sure that 15 years from now the land
will be worth three times what he paid for it.

Rental receipts $ 167,000

Less: Building expenses:
Utilities $ 27,150
Depreciation of building 17,340
Property taxes and insurance 20,250
Repairs and maintenance 17,800
Custodial help and supplies 50,000 132,540
Net operating income $ 34,460

b. Sell the property. A realty company has offered to purchase the property by paying $234,000
immediately and $28,250 per year for the next 15 years. Control of the property would go to the realty
company immediately. To sell the property, Martinas would need to pay the mortgage off, which could
be done by making a lump-sum payment of $122,500.

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Assignment Print View 2021-04-08, 1:40 PM

Click here to view Exhibit 10-1 and Exhibit 10-2, to determine the appropriate discount factor(s) using
tables.

Required:
Assume that Martinas requires a 12% rate of return. Compute net present value in favor of (or against)
keeping the property using the total-cost approach. (Round discount factor(s) to 3 decimal places and
other intermediate calculations to the nearest dollar amount.)

Net present value $ 28,654

Would you recommend that he keep or sell the property?

Keep the property

Explanation:

The net annual cash inflow from rental of the property would be:

Net income, as shown in the problem $ 34,460

Add: Back depreciation 17,340
Net annual cash inflow $ 51,800

Given this figure, the present value analysis would be as follows:

Present
Amount of 12% Value of
Item Year(s) Cash Flows Factor Cash Flows
Keep the property:
Annual mortgage payment 1-8 $ (12,750) 4.968 $ (63,342)
Net annual cash inflow 1-15 51,800 6.811 352,810
Resale value of the property 15 235,500* 0.183 43,097
Present value of cash flows $ 332,565
Sell the property:
Pay-off of mortgage Now $ (122,500) 1.000 $ (122,500)
Down payment received Now 234,000 1.000 234,000
Annual payments received 1-15 28,250 6.811 192,411
Present value of cash flows $ 303,911
Net present value in favour of
$ 28,654
keeping the property

*Land, $53,000 × 3 = $159,000, plus building, $76,500 = $235,500.

Thus, Professor Martinas should be advised to keep the property. Note that even if the property were
worth nothing at the end of 15 years, it would still be more desirable to keep the property rather than sell it
under the terms offered by the realty company. (332,565 – 43,097 = 289,468 vs 303,911)

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