Question

You’ve had your eye a duplex in your neighborhood. The out-of-state owner rarely visits and doesn’t seem to have much interest in the property. You decide to try to purchase the property from the owner.

From your market research you conclude that the property will generate a Net Operating Income of $68,000 per year for a long time into the foreseeable future.

After speaking with a few brokers, you are confident that the appropriate capitalization rate for properties like this in your market is 8.0%.

(a). You ask the owner how much they’d accept for the property as-is. After many discussions, she tells you she’ll sell it to you for $730,000.

What is the Net Present Value of this investment?

As shown in lecture, use the market capitalization rate to determine the stabilized present value of the property.

Show your work and explain your reasoning.

b) Still assuming a purchase price of $730,000, what is the Internal Rate of Return on this investment? Show your work and explain your reasoning.

c)You call the owner to accept their price….only to have her tell you there is another buyer interested in the property. The owner asks both you and the other buyer to bring her your “highest and best” offers by noon tomorrow.  

What is the highest price you’d be willing to pay for this property? Show your work and explain your reasoning.

d)All other things being equal, as the market capitalization rate increases what happens to the value of an income producing property? Briefly explain your reasoning.

Answer 1

Net operating income per year	68,000.00	$
Capitalisation rate	8%
Purchasing price of house	730,000.00	$
Discounted inflow for infinity	Income per year/ Capitalisation rate
	850,000.00	$
NPV = Discounted inflow - Initial investment
NPV of project	120,000.00	$
IRR of the project is when NPV of project = 0
i.e, Discounted inflow = Initial investment
68000/IRR = 730000
IRR	0.0932
IRR	9.32%
Highest price we can give is when discounted inflow at 8%
i.e, Highest price	850,000.00	$
Lowest price we can give is when discounted inflow at IRR
i.e, Lowest price	730,000.00	$
As market capitalisation rate increases, value of income will reduce. Shown in example below
1. rate 10 %=	68000/.10=	680,000.00	$
1. rate 15 %=	68000/.15=	453,333.33	$