Mason corporation is considering purchasing rental property that provides annual cash flows of $800,000. Rent is expected to increase by 1.8% annually for the foreseeable future. If Mason's return requirement is 12.8% and the rental property is listed at $7,500,000 determine if the property is over or under valued from Mason's perspective.

Question

Quizplus · Accepted Answer

To determine if the property is over or under-valued from Mason's perspective, we need to calculate the present value of the future cash flows using the Gordon Growth Model (a type of Dividend Discount Model for perpetuities with growth) since the rent is expected to increase annually. The formula for the Gordon Growth Model is:$$ PV = \frac{D_1}{r - g} $$Where:- $PV$ = Present Value of the investment- $D_1$ = Cash flow in the first period, which is $800,000 increased by 1.8% for the first year = $800,000 * (1 + 0.018) = $814,400- $r$ = Required rate of return, which is 12.8% or 0.128- $g$ = Growth rate of the cash flow, which is 1.8% or 0.018Plugging the values into the formula gives:$$ PV = \frac{814,400}{0.128 - 0.018} = \frac{814,400}{0.110} = \$7,403,636.36 $$The calculated present value of the property is $7,403,636.36, which is less than the listed price of $7,500,000. Therefore, the property is over-valued from Mason's perspective by the difference:$$ \$7,500,000 - \$7,403,636.36 = \$96,363.64 $$However, none of the provided options exactly match this calculation. Given the options, it seems there might have been a mistake in the calculation or interpretation of the options. Based on the methodology and typical exam questions, the intent might have been to assess understanding of valuation principles rather than exact arithmetic, suggesting a possible error in the setup or interpretation of the provided answer choices.

Mason Corporation Is Considering Purchasing Rental Property That Provides Annual