Question

S. S. Sarkar (S.S.S.), a real estate investment company, is considering investing in a shopping center. The sale price is $5,000,000 and S.S.S. expects to have positive after-tax and after-mortgage payment cash flows from rents of $400,000 for the next three years. S.S.S. can obtain a mortgage with a downpayment of $3,000,000. At the end of the third year, S.S.S. anticipates selling the shopping center for a net after-tax gain on sale of $4,500,000. If S.S.S.'s required return is 30%, should S.S.S. go ahead and purchase the shopping center?

Answer 1

S. S. Sarkar (S.S.S)

S.S.S. should not purchase the shopping center.

It will generate a negative NPV.

Step-by-step explanation:

a) Data and Calculations:

Selling price of a shopping center = $5,000,000

Expected annual positive after-tax and after-mortgage payment cash flows form rents = $400,000

Down Payment = $3,000,000

Net after-tax gain on sale after three years = $4,500,000

S.S.S.'s required return = 30%

Annuity value factor for 3 years at 30% = 1.816

Present value factor for 3 years at 30% = 0.455

NPV: Cash Flows PV

Down payment $3,000,000 ($3,000,000)

Annual rent $400,000 $726,400 ($400,000 * 1.816)

After-tax gain $4,500,000 2,041,500 ($4,500,000 * 0.455)

NPV = ($226,100)