Your company is negotiating to get a new head office listed for $25,000,000. The owner has proposed the following payment plan for the next 20 years 20% down payment and annual payments of 1.8 million for the next 10 years starting one year from now. For years 11 through 15, the annual payments balloon to $3 million. For years 16 through 20, the annual payments would decline to $400,000. a. Do you advise your company to accept this offer if the interest rate is 6% for real estate. b. Determine the break even interest rate for the given payment plan, assuming that the fair value of the office building is equal to its list price.
Your company is negotiating to get a new head office listed for $25,000,000. The owner has proposed the following payment plan for the next 20 years 20% down payment and annual payments of 1.8 million for the next 10 years starting one year from now. For years 11 through 15, the annual payments balloon to $3 million. For years 16 through 20, the annual payments would decline to $400,000. a. Do you advise your company to accept this offer if the interest rate is 6% for real estate. b. Determine the break even interest rate for the given payment plan, assuming that the fair value of the office building is equal to its list price.
1-$25,000,000 X 20% =$5,000,000 down payment that the company must pay.
2-We find the PV of the payments of $1,800,000 for the first 10 years at 6% which comes to=$13,248,156.69.
3-We find the PV of the payments of $3,000,000 for the next 5 years at 6% which comes to =$12,637,091.36.
4-We find the PV of the payments of $400,000 for the next 5 years at 6% which comes to =$1,684,945.51.
5-We add all the amounts in 1-4, which comes to =$32,570,193.56.
The total in 5 above is some $7,500,000 greater that the listed price of the office building. Based on this, you certainly wouldn't recommend to the company to accept the deal. It would be much cheaper for the company to purchase the building outright.
If the company could not afford to buy the office building, then a fair lease plan for 20 years at 6% would require the company to make regualr annual payments of $2,179,613.92 which would equate to the fair market value or the listing price of the office building.
On the other hand, since the total amount of the above payments, including the down payment, comes to =$40,000,000, a break even interest rate that would equate this amount to the list price of the office building would be about 6.65%.
There is an error in the PV of $3,000,000 and $400,000 payments.
3- The PV in 3 above should be $7,056,485.81.
4- The PV in 4 above should be $703,068.89.
So, the total PV of ALL the payments plus the $5,000,000 down payment comes to =$26,007,711.39. Now, this amount is much closer to the listed price of the office building. However, it would still be cheaper to buy the building outright, by about a $1,000,000.
If the company could not afford to buy the office building, then a fair lease plan for 20 years at 6% would require the company to make regualr annual payments of $2,179,613.92 which would equate to the fair market value or the listing price of the office building.
On the other hand, since the total amount of the above payments, including the down payment, comes to =$40,000,000, a break even interest rate that would equate this amount to the list price of the office building would be about 6.65%.
