W3_HPO_House Rent


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:

Figure 1.

PV Annuity Equation

and the cost of capital defined as:

Figure 2.

WACC Equation

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.

Figure 3.

Mutual Funds Return

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:

Figure 4.

WACC Calculation

My cash flow stream will be:

Figure 5.

Cashflow Chart

Because there is an annual rent growth of 10% per year, we have to modify the formula

Figure 6.

Modified Formula

The Annuity Calculation will be:

Figure 7.

Annuity Calculation

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.

References:

Anonym (2013). Tarif Pajak Penghasilan Pribadi dan Penghasilan Tidak Kena Pajak (PTKP). [ONLINE] Available at: http://www.putra-putri-indonesia.com/tarif-pajak-penghasilan.html. [Last Accessed 16 September 2013].

J. Erna (2013). 20 reksa dana saham dengan return tertinggi. [ONLINE] Available at: http://ekbis.sindonews.com/read/2013/04/12/32/737333/20-reksa-dana-saham-dengan-return-tertinggi. [Last Accessed 16 September 2013].

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.

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3 Comments

Filed under Hadianto P, Week 03

3 responses to “W3_HPO_House Rent

  1. AWESOME, Pak Hadianto!! I loved it!!! Great case study and you did a fantastic job on your analysis. I especially liked the way you calculated your WACC. Well done!!! The only piece you missed was differentiating between your WACC and your MARR, but you can pick that up in another posting. (See Engineering Economy, pages 179-180, 309-310, 453 and 531-533.

    Keep up the good work and looking forward to seeing more postings like this.

    BTW, we have also done the same kind of project near the UI campus in Depok and did quite well when we sold it after 4 years…..!!!

    BR,
    Dr. PDG, Jakarta

  2. PS Pak Hadianto, while I understand why you used Excel, keep in mind that when you take your AACE Certification Exams, you cannot use Excel so between now and the end of the course, you need to learn how to do these same calculations using your Business Analyst calculator…….. Better you start learning now than later…..

    BR,
    Dr. PDG, Jakarta

  3. Hadianto Prasetio

    Thank you Sir. I will practice your order.

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