Question

You can purchase a tract of land for $75,000 that you believe you can develop and sell as a residential development. Your development costs are $60,000 to be incurred immediately. You expect to sell all the lots in years 3-5 at a net income of $70,000, $85,000, and $68,000 respectively. Your required rate of return is 12 percent. Do you purchase the tract of land? HTML EditorKeyboard Shortcuts

Answer 1

The tract of land should be purchased

Step-by-step explanation:

To determine if the land should be bought, compare the present value of the income that would be derived from selling the lots to the cost of the land

Total cost of the land = $75,000 + $60,000 = $135,000

Present value is the sum of discounted cash flows

Present value can be calculated using a financial calculator

Cash flow in year 1 and 2 = 0

Cash flow in year 3 = $70,000

Cash flow in year 4 = $85,000

Cash flow in year 5 = $68,000

I = 12%

Present value = $142,428.68

The tract of land should be purchased because the present value of the cash flows is greater than the cost of the land

To find the PV using a financial calculator:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. after inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.

3. Press compute