The Wharton School
Professor Jeffrey Jaffe
Spring 2006
Corporate Finance 100
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The Wharton School
Professor Jeffrey Jaffe
Spring 2006
Question 1 (20 points)
The date is 12/31/05.
Assume that all cash flows occur at the end of each calendar year.
The Marsh Company (Marsh) is considering a 10year investment in commercial real estate.
The purchase price is $20MM (Million), payable today, and Marsh will rent the property for
10 years beginning in 2006. After ten years it will have a resale value of $7MM in real terms.
The company uses straight line depreciation.
Assume that, for tax purposes, assets are
depreciated to zero by the end of year 10.
Marsh will rent the property for a real value of
$5MM in 2006, and then increase the rent by 1.5% per year in real terms for the next ten
years.
Maintenance fees will be $3MM per year in real terms.
The income tax rate is 35% for both ordinary income and capital gains, and the opportunity
cost of capital for this type of investment is 11% in real terms. The annual inflation rate will
be 6% for the next ten years. The company is currently profitable.
a)
Calculate the Net Present Value of the project. (15 points)
b)
Now assume that Marsh wants to change the yearly rental fee so that the investment
exactly breaks even (i.e. NPV = 0). If the rent still grows by 1.5% per year in real
terms, by what amount will the first year’s rent have to change so that the NPV equals
zero? (5 points)
Solution
a)
Calculations
NPV = PV( Purchase Price + Rental Revenue – Maintenance Fees
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 Spring '10
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 Depreciation, Inflation, Corporate Finance, Net Present Value, Professor Jeffrey Jaffe, Wharton School Spring

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