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 $7,000,000 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 and compare it to the listed price. The cash flows are growing perpetually at a rate of 1.8%, so we use the Gordon Growth Model (a version of the Dividend Discount Model for perpetuities with growth) to calculate the present value (PV) of the property:$$ PV = \frac{D_1}{r - g} $$Where:- $D_1$ is the cash flow in the first year, which is $800,000.- $r$ is the required rate of return, which is 12.8% or 0.128.- $g$ is the growth rate of the cash flows, which is 1.8% or 0.018.First, we calculate $D_1$, which is already given as $800,000. Then, we plug the values into the formula:$$ PV = \frac{800,000}{0.128 - 0.018} = \frac{800,000}{0.110} = \$7,272,727.27 $$The calculated present value of the property is $7,272,727.27. Since the property is listed at $7,000,000, it is under-valued by the difference:$$ \$7,272,727.27 - \$7,000,000 = \$272,727.27 $$Therefore, from Mason's perspective, the property is under-valued by approximately $272,727.

Mason Corporation Is Considering Purchasing Rental Property That Provides Annual