YOU HAVE BEEN SO SUCCESSFUL IN YOUR FINANCE CAREER THAT YOU CAN BUY...
7. You have been so successful in your finance career that you can buy a second condo today for $1.5 million. You think you can sell it in five years for $2 million. You will also earn $120,000 per year in rent on the property in years 2 to 5 (only) and the rental income occurs at the end of each year. If you want to earn at least a 10% annual return on your investment, should you buy the condo? A) Yes, the present value of all the cash inflows is greater than the purchase price. B) Yes, the future value of the rental income is greater than the selling price. C) No, the present value of all the cash inflows is less than the purchase price. D) No, the future value of the rental income is less than the selling price. E) You are indifferent as the cash inflows equal the cash outflows. Solution A First, find the PV of the rental payments (delayed annuity) and then add PV of selling price. Using your calculator: PMT = 120,000; n= 4; I/Y = 10%; FV = 0 , COMP PVPV ordinary annuity = 380,383.85 PV Delayed Annuity = 380,383.85 /(1.10) = 345,803.50 PV of selling price = 2,000,000/(1.10)
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= 1,241,842.65 Total PV = 345,803.50 + 1,241,842.65 = 1,587,646.15 Since Total PV cash inflows > Purchase price Yes, you should buy the condo.