An investor is considering to buy a property. It costs $200.000,00 and it will allow him to receive $28.000,00 during the first year (which will decrease $300,00 per year). If he buys this property, he expects to keep it for 10 years and then sell it for $140.000,00.

On the other hand, he owns a property of $150.000,00 which will be shall be sold to buy the former property. This last property gives him $21.000,00 per year for 10 years, when he expects to sell it (if he does not do it now) for $110.000,00.

Given that the minimum attractiveness rate of 8%, is it worthwhile to buy the property?

I am wondering how to represent the cash flow of these two options to compare their IIR, but I'm not quite sure about some details:

1) If he chooses to buy the property, would his initial investiment be $200.000,00 - $150.000,00?

2) The second option (not buying it) has no output of money, he just gets money. So, how do I evaluate the IRR in this case?

Thank you

  • 1
    It may be worth noting that the great majority of English speaking countries use a dot as the decimal separator and a comma as the thousands separator. If I someone write "$300,00", then I'm not sure whether they meant "$30,000" (thirty thousand dollars), "$300,000") (three hundred thousand dollars), or "$300.00" (three hundred dollars and zero cents). – Tanner Swett May 12 '20 at 3:54
  • I don't really understand what you are asking? – Victor May 12 '20 at 6:11

Comparing their IRR is not the right approach to the actual question - "Is this a worthwhile investment?" You are given the required return (8%) and would take the net cash flow for each period. If the NPV of the combined projects is positive then it's a worthwhile project.

The cash flows for Property 2 that are "lost" when it is sold could be considered cash losses. So your cash flows would be:

          Prop 1      Prop 2
        ========    ========
Year 0: -200,000 +   150,000 =  -50,000
Year 1:   28,000 +  - 21,000 =    7,000
Year 2:   27,700 +  - 21,000 =    6,700
Year 10: 165,300 +  -131,000 =   34,300

(Year 10 is the income from the last year plus the salvage value)

Then, calculate the NPV using an 8% discount factor to determine if the PV is positive or negative.

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