Tranquil Manor Case Study Tranquil Manor is a 33,000 square foot apartment complex located at 1000 Raucous Causeway, South Haven, CT 06999. The location is fully built-up and well established with multi-family housing. The prevailing capitalization rate in this area for properties such as this is 11%. You are contemplating the purchase of this property on December 31, 2005. The building is brick, about 50 years old and has been well-maintained. There is no evidence of deferred maintenance or of the need to replace the roof or mechanicals at any time in the near future (no CapEx needed). 75% of the value of the property lies in the building and 25% in the land. Use straight line depreciation (1/27.5 per year) for life of building which is 27.5 years for a residential income-producing property. The building has 48 apartments. Every apartment is occupied and all leases expire within a year or less. The owner has presented us with the following rent roll information: 10 studio apartments @ $700 each 30 1-bedroom apartments @ $950 each 8 2-bedroom apartments @ $1,150 each (A note on data entry: Dont enter 48 individual apartments into the rent roll; its an unnecessary exercise. Make only three entries, one for each type of apartment, and aggregate the rent for each. For example, as the first tenant enter a name such as 10 studio apartments @ $700 and the first years rent as 7000.) Your research shows that these rents are realistic in this market and also that rents have been increasing at about 2% per year. Although there are no vacancies now, you will estimate a 2% vacancy loss. You combine the owners representations with your knowledge of similar buildings and come up the following estimate of first-year operating expenses: Accounting 2,500 Insurance (fire and liab.) 29,300 Lawn/Snow 7,400 Legal 6,200 Miscellaneous 3,200 Property Management 38,400 Repairs and Maintenance 29,300 Supplies 7,400 Real Estate Taxes 42,600 Trash Removal 18,600 Electricity 12,200 Sewer and Water 29,500 Telephone 800

You believe that each of these expenses will increase at 3% per year except insurance (5%) and real estate taxes (4%). The sellers asking price is $3 million. You believe you can obtain financing for 80% of the purchase price. The terms are a 7% interest rate, 240-month term and 2 points. You plan to sell at the end of 2010. Selling price is based on 3% expected annual appreciation. You also expect to pay 7% of the selling price as your cost of sale when you eventually dispose of the property. You have a 30% income tax and 20% capital gains tax. The depreciation recapture tax rate is 25%.

What is the effective tax rate?

A. 24.05%

B. 28.64%

C. 22.87%

D. 21.14%