1. Problem Statement
I have bought an old house at $ 130,000 which I intended to change it into a dorm house. Because it’s an old house I should renovate it into 10 rooms. I predict the dorm house will have 10 years useful life . The renovation will cost me around 80% of old house acquisition cost. I predict I can get at least 10% gain/increase per annum conservatively of my land value. I bought the old house by 50% own capital and 50% debt. Tax of my revenues averagely around 30%. How much should I charge minimum per month to each customer at year 1 (one) if I can get at least 10% increase rent each year? Assumption: all rooms will be full occupied at year 1.
2. Identification of Feasible Alternatives
According to Sullivan, the time value of money of annuity is defined as:
and the cost of capital defined as:
3. Development Outcomes of Each Alternative
The analysis will find the WACC and Annuity. The cost of equity of my own capital is the opportunity cost by investing it in the mutual fund.
4. Selection of Acceptable Criteria
I should get the present value of total acquisition cost (old house+renovation) minimum equal to the sum of increasing Annuity charged by WACC each year for 10 years dorm house useful life.
5. Analysis & Comparison of Alternatives
The WACC will be:
My cash flow stream will be:
Because there is an annual rent growth of 10% per year, we have to modify the formula
The Annuity Calculation will be:
6. Selection of Preferred Alternatives
Based on the result of annuity calculation at year 1 is at US$ 23,474.13, thus each month at year 1, I must get minimum US$ 1,956.18 from all occupants. And at year 2 I will get 10% increase of my dorm house revenue as US$ 2,151.80 each month and so on.
7. Follow-up Result
Because my dorm house has 10 rooms, I will charge each occupant per month at year 1 minimum as much as US$ 195.62.
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Sullivan, W. G., Wicks, E. M., & Koelling, C. P. (2012). The Time Value of Money. In Engineering Economy (15th ed., pp. 104-162). Upper Saddle River, N.J: Prentice Hall.
Sullivan, W. G., Wicks, E. M., & Koelling, C. P. (2012). The Capital Budgeting Process. In Engineering Economy (15th ed., pp. 523-547). Upper Saddle River, N.J: Prentice Hall.