Raul Martinas, 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 $541,000-$53,000 for the land and $488,000 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, so Professor Martinas is unsure whether he should keep it or sell it. Assume that Professor Martinas requires a 15% rate of return. His alternatives are:
Alternative 1: Keep the property. Professor Martinas' 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:
- Rental receipts $133,000
- Less building expenses:
- Utilities $24,900
- Depreciation of building 15,100
- Property taxes and insurance 17,000
- Repairs and maintenance 8,100
- Custodial help and supplies 38,800
- Total Building Expenses 103,900
- Net operating income 29,100
Professor Martinas makes a $12,200 mortgage payment each year on the property. The mortgage will be paid off in 8 more years. He has been depreciating the building by the straight-line method, assuming a salvage value of $110,500 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.
Alternative 2: Sell the property. A realty company has offered to purchase the property by paying $177,000 immediately and $26,300 per year for the next 15 years. Control of the property would go to the realty company immediately. To sell the property, Professor Martinas would need to pay the mortgage off, which could be done by making a lump-sum payment of $91,600.
To determine the appropriate discount factor(s) using tables, click here to view Exhibit 12B-1 and Exhibit 12B-2. Alternatively, if you calculate the discount factor(s) using a formula, round to three (3) decimal places before using the factor in the problem.
Required:
(a)Calculate the present value of cash flows if he keeps the property.
(b)Calculate the present value of cash flows if he sells the property.
(c) Would you recommend he keep or sell the property?