Question

You have an opportunity to acquire a property form First Capital Bank. The bank recently obtained the property from a borrower who defaulted on his loan. First Capital is offering the property for $200,000. If you buy the property, you believe that you will have to spend (1) $10,500 on various acquisition-related expenses and (2) an average of $2,000 per month during the next 12 months for repair costs, etc., in order to prepare it for sale. Because First Capital Bank would like to sell the property ASAP, it is willing to provide $180,000in financing at 8 percent interest for 12 months payable monthly (interest only). Your market research indicates that after you repair the pretty, it may sell for about $225,000 at the end of one year. Furthermore, you will probably have to pay about $3,000 in fees and selling expenses in order to sell the property at that time?

Answer 1

Answer:

Acquiring the property will not be profitable. This is supported by the computation below;

Cash outflow required;

Offer cost                           $200,000

Other acquisition cost           $10,500

Repairs cost                           $12,000

Selling expenses and fee       $3,000

Loan Interest (180,000x8%)    $14,400

 Total                                   $239,900

Expected selling price         $225,000

Expected Loss                         $14,900

Explanation:

It is assumed that the $180,000 loan from the bank will be completely absorbed in the process of bringing the property into a good selleable condition.  Also, the interest payable on loan will be paid monthly which will affect the liquidity of the buyer. Except funds are sought for somewhere else, the buy can not pay for the initial cost of the property. The venture will not be profitable.

Workings:

Cash outflow required;

Offer cost                           $200,000

Other acquisition cost           $10,500

Repairs cost                           $12,000

Selling expenses and fee       $3,000

Loan Interest (180,000x8%)    $14,400

 Total                                   $239,900

Expected selling price         $225,000

Expected Loss                         $14,900