Question 1: Disposition and Renovation Decisions I. An investor has owned a property for five years. A property could be sold today for $2 million. It has a loan balance of $ 1 million and, if sold, the investor would incur a total of $250,000 in taxes (capital gains tax + depreciation recapture tax). The investor has determined that if it were sold today, she would have earned an IRR of 15% on equity for the past five years. If not sold, the property is expected to produce after tax cash flow of $50,000 over the next two years. At the end of the two years, the property value is expected to increase to $2.1 million, the loan balance will decrease to $900,000. If sold after two years, the investor would incur a total of $255,000 in taxes. A. What is the incremental internal rate of return for keeping the property two additional years? B. The investor has an outside investment opportunity that is expected to earn him a rate of return of 15%. What advice would you give the investor? II. (Continuation of Question 1) The owner determines that if the property were renovated instead of sold, after tax cash flow over the next two years would increase to $60,000 and the property could be sold after two years for $2.4 million. Renovation would cost $250,000. The investor would not borrow any additional funds to renovate the property. Assume that taxes due on sale after two years would be $255,000. C. What is the rate of return the investor would earn on the additional funds invested in renovating the property (compared to not renovating the property and continuing to operate it as is)? D. The investor has an outside investment opportunity that is expected to earn him a rate of return of 15%. Would you recommend the property be renovated?
Question 1: Disposition and Renovation Decisions I. An investor has owned a property for five years. A property could be sold today for $2 million. It has a loan balance of $ 1 million and, if sold, the investor would incur a total of $250,000 in taxes (capital gains tax + depreciation recapture tax). The investor has determined that if it were sold today, she would have earned an IRR of 15% on equity for the past five years. If not sold, the property is expected to produce after tax cash flow of $50,000 over the next two years. At the end of the two years, the property value is expected to increase to $2.1 million, the loan balance will decrease to $900,000. If sold after two years, the investor would incur a total of $255,000 in taxes. A. What is the incremental internal rate of return for keeping the property two additional years? B. The investor has an outside investment opportunity that is expected to earn him a rate of return of 15%. What advice would you give the investor? II. (Continuation of Question 1) The owner determines that if the property were renovated instead of sold, after tax cash flow over the next two years would increase to $60,000 and the property could be sold after two years for $2.4 million. Renovation would cost $250,000. The investor would not borrow any additional funds to renovate the property. Assume that taxes due on sale after two years would be $255,000. C. What is the rate of return the investor would earn on the additional funds invested in renovating the property (compared to not renovating the property and continuing to operate it as is)? D. The investor has an outside investment opportunity that is expected to earn him a rate of return of 15%. Would you recommend the property be renovated?
Chapter10: Capital Budgeting: Decision Criteria And Real Option
Section: Chapter Questions
Problem 20P
Related questions
Question
Please answer in excel and show steps, thank you.
Transcribed Image Text:Question 1: Disposition and Renovation Decisions
An investor has owned a property for five years. A property could be sold today for $2 million. It has a
loan balance of $ 1 million and, if sold, the investor would incur a total of $250,000 in taxes (capital
gains tax + depreciation recapture tax). The investor has determined that if it were sold today, she would
have earned an IRR of 15% on equity for the past five years. If not sold, the property is expected to
produce after tax cash flow of $50,000 over the next two years. At the end of the two years, the property
value is expected to increase to $2.1 million, the loan balance will decrease to $900,000. If sold after
I.
two
years,
the investor would incur a total of $255,000 in taxes.
A. What is the incremental internal rate of return for keeping the property two additional years?
B. The investor has an outside investment opportunity that is expected to earn him a rate of return of
15%. What advice would you give the investor?
(Continuation of Question 1) The owner determines that if the property were renovated instead of sold,
after tax cash flow over the next two years would increase to $60,000 and the property could be sold
after two years for $2.4 million. Renovation would cost $250,000. The investor would not borrow any
additional funds to renovate the property. Assume that taxes due on sale after two years would be
$255,000.
II.
C. What is the rate of return the investor would earn on the additional funds invested in renovating the
property (compared to not renovating the property and continuing to operate it as is)?
D. The investor has an outside investment opportunity that is expected to earn him a rate of return of
15%. Would
you recommend the property be renovated?
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 4 steps with 4 images
Recommended textbooks for you
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:
9781337514835
Author:
MOYER
Publisher:
CENGAGE LEARNING - CONSIGNMENT
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:
9781337514835
Author:
MOYER
Publisher:
CENGAGE LEARNING - CONSIGNMENT
College Accounting (Book Only): A Career Approach
Accounting
ISBN:
9781337280570
Author:
Scott, Cathy J.
Publisher:
South-Western College Pub
Survey of Accounting (Accounting I)
Accounting
ISBN:
9781305961883
Author:
Carl Warren
Publisher:
Cengage Learning
Principles of Accounting Volume 1
Accounting
ISBN:
9781947172685
Author:
OpenStax
Publisher:
OpenStax College