Question

A property produces a first-year net operating income of $24,000. Because of the long economic life of the building, the income is considered as a perpetuity that will grow by 2.5% per year. Using a discount rate of 9.5%, estimate that property value.

A. $276,968

B. $252,632

C. $200,000

D. $342,857

Answer 1

The property value is calculated using the Gordon Growth Model, resulting in a present value of $342,857, which is option D.

Step-by-step explanation:

The question pertains to calculating the present value of a property's future income streams. Specifically, we are asked to find the value of a property that produces a first-year net operating income of $24,000, which grows by 2.5% annually and is considered a perpetuity. The discount rate given is 9.5%.

To estimate the property value, we use the Gordon Growth Model (also known as the Dividend Discount Model for perpetuities), which is given by the formula:

PV = D / (r - g)

Where:

• PV = Present Value of the property
• D = Net Operating Income in the first year
• r = Discount rate
• g = Growth rate of the income

In this case:

PV = $24,000 / (0.095 - 0.025)

PV = $24,000 / 0.07

PV = $342,857

Therefore, the estimated value of the property is $342,857, which corresponds to option D.