Question: You have decided to invest in a small commercial office building that has one tenant. The tenant has a lease that calls for annual rent payments of $20,000 per year for the next three years. However, after that lease expires you expect to be able to increase the rent by 5% per year for the next seven years. You plan to sell the building for $300,000 ten years from now.
a. You have decided to invest in a small commercial office building that has one tenant. The tenant has a lease that calls for annual rent payments of $20,000 per year for the next three years. However, after that lease expires you expect to be able to increase the rent by 5% per year for the next seven years. You plan to sell the building for $300,000 ten years from now.
b. Create a table showing the projected cash flows for this investment assuming that the next lease payment will be made in one year.
c. Assuming that you need to earn 11% per year on this investment, what is the maximum price that you would be willing to pay for the building today? Use the NPV function.
d. Notice that the cash flow stream starts out as a three-year regular annuity, but it then changes into a seven-year graduated annuity plus a lump sum in year 10. Use the principal of value additivity to calculate the present value of the cash flows.
e. Suppose that the current owner of the building is asking $200,000 for the building. If you paid this price, what annual rate of return would you earn? Should you buy the building at this price?