A real estate appraiser is assessing the value of a piece of land in Vancouver. Currentlythe land is unoccupied but is zoned for commercial use. Plans have been approved tobuild a five-story office building. Construction is expected to start in1 year and will take2 years to complete, at a total cost of $3 million. For simplicity, assume that the costs arepaid in equal amounts at the start of each construction year.
(a) Suppose a constant annual cash flow of $400,000, net of all taxes and operating costs, is expected at the end of each year of operation, and the building lasts forever. What isthe maximum you could be willing to pay for the land if the discount rate is 8 percent?Explain your answer.
(b) If the cash flow from the tenants grows at 1.5 percent per year, after the first year ofoccupancy, recalculate the price you would be willing to pay for the land.