A real estate appraiser is assessing the value of a piece of land in Vancouver. Currently the land is unoccupied but is zoned for commercial use. Plans have been approved to build a five-storey office building. Construction is expected to start in 1 year and will take 2 years to complete, at a total cost of $3 million. For simplicity, assume that the costs are paid in equal amounts at the start of each construction year.
a. Suppose a constant annual cash flow of $400,000, net of all taxes and operating costs, is expected at the end of each year of operation, and the building lasts for SO years. What is the maximum you would be willing to pay for the land if the discount rate is 8%? Explain your answer.
b. If the cash flow from the tenants grows at 1.5% per year, after the first year of occupancy, recalculate the price you would be willing to pay for the land.