15. 7.20 Nick and Helen Adams have been offered a chance to invest in a Real Estate Trust that pays annual benefits estimated at $12,000 for a lump sum investment now of $70,000. The agent mentioned that there is a small capital improvement fund cost of $2000 per year. He also mentioned that the projected profitability index of 1.20 is very favorable since for every $1 invested a return of $1.20 can be expected, over time.

Once the couple understood that the PI was calculated as the equivalent of annual benefits ($12,000) minus costs ($2000) divided by the

$70,000 up-front investment amortized over 40 years at 10% per year, they quickly calculated, in round numbers, the PI to be 1.40, not 1.20. It was clear to them that there is another (hidden) annual cost if the PI of 1.20 is correct.

1. What is the size of this “unmentioned” cost?

2. (Spreadsheet exercise) Assume the agent agreed that there is an additional annual charge equal to the amount calculated in part (a).

Perform a spreadsheet analysis similar to that in Example 7.3

(c) to determine the actual ROR, assuming the couple agreed to the investment and the extra annual cost.