Assignment 3, Question 10

(15 points) Sairah purchased an investment property for $350,000, 3 years ago. The after-tax
cashfow of the property has been $35,000 per year to date, but market conditions have
improved and Sairah expects the cashflow to improve to $42,000 per year for the next 25 years
(assume these are year end cashflows). The annual cost of capital (or cap rate) for this area is
9%. What is the value of the property today?(Enter just the number without the $ sign or a
comma; round off decimals.)
This problem is quite straightforward to solve as long as you dont get caught up in some of the
extra information. As with all problems in finance, the past doesnt matter! Therefore, the value
of the property TODAY has nothing to do with what Sairah paid for it 3 years ago, nor the cash
flow she has been getting from it these past 3 years. What matters are her expectations of the
future cash flows it will bring in, valued in todays dollars. Therefore, the relevant numbers to
use from the problem are the $42,000 in annual cash flow going forwards, a 25 year time
horizon (since the 3 years up to today are in the past), and a 9% cap rate. Plug these into the PV
formula and you should come up with the right answer!

This time
period is
irrelevant!

Expected Annual Cash Flow=$42,000

T= -3

T=0

House
purchase
for $350K

TODAY!

T=25

Capitalization Rate=9%

End of
investment