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Q: accounting ( Answered 5 out of 5 stars,   0 Comments )
Subject: accounting
Category: Business and Money > Accounting
Asked by: fatima1102-ga
List Price: $2.00
Posted: 10 Sep 2005 23:32 PDT
Expires: 10 Oct 2005 23:32 PDT
Question ID: 566667
You are contemplating the purchase of an office building. Next year 
            net rental income will be $400,000, which will grow at 4% per year. 
            You believe that in 10 years the office building could be sold for 
            $7.4 million. The appropriate discount rate for investments of this 
            type is 12%. What is the most you should be willing to pay for the 
            office building today?
Subject: Re: accounting
Answered By: omnivorous-ga on 11 Sep 2005 10:16 PDT
Rated:5 out of 5 stars
Fatima1102 ?

This is a straightforward net-present value problem, discounting cash
flows for the cost of money each year:
?Net Present Value -- NPV? (undated)

It?s common in these computations to set up each year?s NPV factor,
then multiply cash flows times them.  There?s an assumption here that
all cash flows are coming at year-end, done to simplify the
calculations (though they work with a half-year assumption and
slightly different numbers):

Year 1: 1/1.12 = 0.8929
Year 2: 1/(1.12)^2 = 0.7972
Year 3: 1/(1.12)^3 = 0.7118
Year 10: 1/(1.12)^10 = 0.3220

You can now discount everything ? from the annual rents to your final
sale price ? back to an NPV by multiplying it.  I?ve set it all up in
a spreadsheet here:

Your total NPV is $4,999,607 ? so you?d pay any amount up to that level.

Best regards,

fatima1102-ga rated this answer:5 out of 5 stars

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