Cash Equivalency

Development costs are $1,000,000.  The developer can develop 50 lots worth $50,000 net each.  Absorption is 20 lots in each of the first two years and 10 lots in the third year.  If 12% is a reasonable discount rate, what is the value of the raw land.

Answer:

Year 0 = (1,000,000)

Year 1 = 1,000,000 x 0.892857 = $892,857

Year 2 = 1,000,000 x 0.797194 = $797,194

Year 3 = 500,000 x 0.711780 = $355,890

The total of the four cash flows is $1,045,941.  This is the maximum amount that the developer should pay for the raw land.