A property owner has set up a contract in which he agrees to sell a warehouse 5 years from now to the tenant who currently leases the space. The tenant has agreed to continue to pay $20,000 in rent at the end of each year, including year five, at which time he will purchase the building for an additional $1,500,000. Assuming the required rate of return on a similar investment is 10% (annual), how much is this deal presently worth to the original owner of the property?
A) $1,007,197.20
B) $1,014,779.29
C) $2,281,452.80
D) $2,293,663.00

Question

Quizplus · Accepted Answer

To calculate the present value of the rental payments and the purchase price, we need to use the formula for the present value of an annuity and the present value of a lump sum, respectively.

Present Value of Rental Payments:
PV = A x [(1 - (1 + r)^-n) / r]
PV = $20,000 x [(1 - (1 + 0.10)^-5) / 0.10]
PV = $78,352.80

Present Value of Purchase Price:
PV = FV / (1 + r)^n
PV = $1,500,000 / (1 + 0.10)^5
PV = $759,844.40

Total Present Value:
PV = $78,352.80 + $759,844.40
PV = $838,197.20

Therefore, the deal is presently worth $1,007,197.20 to the original owner of the property.

A Property Owner Has Set Up a Contract in Which