Question: A real estate developer seeks to determine the most economical height for a new office building. The building will be sold after 5 years. The
A real estate developer seeks to determine the most economical height for a new office building. The building will be sold after 5 years. The relevant net annual revenues and salvage values are as follows:
|
| Height | |||
|
| 2 Floors | 3 Floors | 4 Floors | 5 Floors |
| First cost (net after-tax) | $500,000 | $750,000 | $1,250,000 | $2,000,000 |
| Lease revenue | 199,100 | 169,200 | 149,200 | 378,150 |
| Net resale value (after-tax) | 600,000 | 900,000 | 2,000,000 | 3,000,000
|
(a) The developer is uncertain about the interest rate (i) to use, but is certain that it is in the range of 5% to 30%. For each building height, find the range of values of i for which that building height is the most economical. (b) Suppose that the developers interest rate is known to be 15%. What would be the cost, in terms of net present value, of an error in overestimation in resale value (the true value resulted in a value 10% lower than that of the original estimate)?
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