You are considering the purchase of a parcel of land for $20 million, which sits on the edge of a growing part of
Phoenix. You expect significant residential and commercial growth to reach this area within the next 10 years, greatly lifting the value of the property. You have an idea: purchase the land now, lease it to an individual for 10 years who will create an commuter parking lot together with a bus service into the heart of the city, and then you sell the land after 10 years for an estimated $50 million after-tax.
You estimate you can lease the land to the individual for $1 million before-tax for the first year, with an escalation clause of 3% per year. You will also face property tax expense of $0.1 million for the first year which you estimate will increase 3% per year. You will be able to deduct the property tax from your lease revenues for tax purposes. Assume the first lease and property tax payments occur at the end of year 1.
Your tax rate is 25 percent, and your cost of capital (discount rate) is 10 percent.
What is the Net Present Value (NPV) now (end of year 0) of purchasing the land, leasing it, and selling it after 10 years per the estimated factors above?
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