Keep or Sell Property [LO1]

Ben Ryatt, professor of languages at a southern university, owns a small office building adjacent to the university campus. He acquired the property 12 years ago at a total cost of $560,000—$52,000 for the land and $508,000 for the building. He has just received an offer from a realty company that wants to purchase the property; however, the property has been a good source of income over the years, so Professor Ryatt is unsure whether he should keep it or sell it. His alternatives are:

Keep the property. Professor Ryatt’s accountant has kept careful records of the income realized from the property over the past 10 years. These records indicate the following annual revenues and expenses:

Rental receipts . . . . . . . . . . . . . . . . . . . . . . . . . $150,000 Less building expenses:

Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $28,600 Depreciation of building . . . . . . . . . . . . . . . . 17,800 Property taxes and insurance . . . . . . . . . . . . 19,500 Repairs and maintenance . . . . . . . . . . . . . . . 10,500 Custodial help and supplies . . . . . . . . . . . . . 43,500 119,900 Net operating income . . . . . . . . . . . . . . . . . . . . $ 30,100 Professor Ryatt makes a $12,600 mortgage payment each year on the property. The mortgage will be paid off in 10 more years. He has been depreciating the building by the straight-line method, assuming a salvage value of $9,600 for the building, which he still thinks is an appropriate figure.

He feels sure that the building can be rented for another 16 years. He also feels sure that 16 years from now the land will be worth 2.5 times what he paid for it.

Sell the property. A realty company has offered to purchase the property by paying $150,000 immediately and $23,000 per year for the next 16 years. Control of the property would go to the realty company immediately. To sell the property, Professor Ryatt would need to pay the mortgage off, which could be done by making a lump-sum payment of $71,000.

Required:

(Ignore income taxes.) Professor Ryatt requires a 14% rate of return. Would you recommend he keep or sell the property? Show computations using the total-cost approach to net present value.