Question
Vacant land has been zoned for either one 10,000-square-foot five-unit apartment block or two single-family homes, each with 3,000 square feet. The cost of constructing
Vacant land has been zoned for either one 10,000-square-foot five-unit apartment block or two single-family homes, each with 3,000 square feet. The cost of constructing the single-family homes is 100 per square foot and the cost of constructing the apartments is 120 per square foot. If the property market does well next year, the homes can be sold for 300 per square foot and the apartments for 230 per square foot. If the market performs poorly, the homes can be sold for 200 per square foot and the apartments for 140 per square foot. Today, comparable homes could be sold for 225 per square foot and comparable apartments for 180 per square foot. First-year rental rates (paid at the end of the year) on the comparable apartments and homes are 20 per cent and 10 per cent, respectively, of todays sales prices.
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What is the implied risk-free rate, assuming that short selling is allowed?
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