Question

32. Suppose Schmidt owns some land and is trying to decide when to sell it for a shopping center development. Her goal is to maximize her net worth, the present value of her other income stream plus the value of the land or the value of investment made with the proceeds of selling the land. The interest rate is 5% on financial investment. The land is now worth $100K if sold. Suppose that the value of the land is expected to increase at a rate that will slowly decrease over time as she waits.

A. Suppose Schmidt expects the land to be worth $104K next year. Should she sell now? Why?

B. If she expects it to be worth $110K in a year, should she sell now? Why?

C. At what next year land value would Schmidt be indifferent between selling and holding a year?

Answer 1

Given that,

The interest rate on financial investment = 5%

The present worth of land = $100,000

If Schmidt sells the land now and invests the amount received in financial investment, she would possess $100,000 x (1+0.05) = $105,000 at the end of next year

A. If she expects the land to be worth $104,000 next year, she should sell the land now. This is because by selling the land now and investing the proceeds in financial investment will increase her present worth as the future worth, in this case, is $105,000 which is higher than $104,000(the worth of land next year)

B. If she expects the land to be worth $110,000 next year, she should not sell the land now. This is because by selling the land now and investing the proceeds in financial investment will decrease her present worth as the future worth, in this case, is $105,000 which is lesser than $110,000(the worth of land next year)

C. Schmidt would be indifferent between selling or holding a year if the proceeds from selling and further financial investment is equal to the expected worth of land next year. This happens when the expected land value in the nest year is $105,000