Question

a property, if sold today, will provide the equity investor with $550,000 in cash flow after taxes. if the property is held, the annual after-tax cash flow received by the investor will be as follows: $55,000 in year 1 with 4% growth each year. if held and sold in 10 years, the property is expected to provide $600,000 in after-tax cash flow to the investor. what should the investor do if she can receive a 13% rate of return by investing the sales proceeds today in a different project

Answer 1

To decide whether to sell or hold the property, the investor must compare the NPV of selling and investing at a 14% rate of return versus the NPV of the cash flows from holding the property for 10 years. Without knowing the NPV from holding the property, we cannot determine the better option. Therefore, the answer is (D) Can't tell without knowing the cash flow from the second property.

The investor needs to compare the net present value (NPV) of selling the property today and investing in a different project with a 14% rate of return against the NPV of holding the property for 10 years with the cash flows provided. Assuming a 14% discount rate, the NPV of selling today and investing would simply be the $150,000 in cash flow.

For holding the property, the NPV is calculated with the cash flows over the 10-year period:

1. Years 1-5: $18,000 per year
2. Years 6-10: $24,000 per year
3. End of Year 10: $180,000 (from the sale)

Using these figures, we calculate the NPV for holding and selling after 10 years. If this NPV is higher than $150,000, the investor should hold the property, otherwise, she should sell and invest in the different project.

Since this calculation depends on precise figures, to make a sound decision the investor must perform the calculation.

Without knowing the NPV of the cash flows from holding the property, we can't determine if she should sell the property or not. Thus, the correct answer is (D) Can't tell without knowing the cash flow from the second property.

Complete Question

A property, if sold today, will provide the equity investor with $150,000 in cash flow after taxes. If the property is held, the annual after-tax cash flow received by the investor will be as follows: $18,000 for years 1 to 5, $24,000 for years 6 to 10. If held and sold in 10 years, the property is expected to provide $180,000 in after-tax cash flow to the investor. What should the investor do if she can receive a 14% rate of return by investing the sales proceeds today in an different project? (B)

(A) Sell the property and invest proceeds in the second property

(B) Do not sell the property

(C) Renovate the property

(D) Can’t tell without knowing the cash flow from the second property