A tract will yield 40 lots selling at $80,000 each. Development costs are $1,200,000, sales and marketing run 8 percent of gross, and the developer requires a 20 percent profit on gross. Ignoring discounting, what land value is indicated?
Correct Answer
A) $1,104,000
Why this is correct: This is a development residual (land residual) problem. The indicated land value is the residual after deducting all costs and profit from the gross sales revenue. Step 1: Calculate Gross Sales: 40 lots * $80,000 = $3,200,000. Step 2: Calculate Sales/Marketing Cost: 8% of $3,200,000 = $256,000. Step 3: Calculate Required Profit: 20% of $3,200,000 = $640,000. Step 4: Sum all deductions: Development Costs ($1,200,000) + Marketing ($256,000) + Profit ($640,000) = $2,096,000. Step 5: Land Value = Gross Sales - Total Deductions: $3,200,000 - $2,096,000 = $1,104,000. Why the other choices are wrong: "$1,360,000" results from miscalculating deductions, possibly omitting profit. "$2,000,000" is close to the total deductions, not the residual land value. "$944,000" might result from an error in calculating the percentage-based costs (e.g., applying 8% and 20% to the wrong base). Exam tip: In residual problems, carefully identify what each percentage applies to (usually gross revenue) and deduct in the correct order: hard costs, then soft costs, then profit.
Why This Is the Correct Answer
Option A is correct at $1,104,000. Gross sales of $3,200,000 less $256,000 of sales and marketing, less $640,000 of developer profit, less $1,200,000 of development costs leaves $1,104,000. Both percentage deductions are computed on gross sales because the problem states them that way. The land is the residual claimant, receiving only what survives after every other cost and the profit requirement are satisfied, which is why the method is a direct application of surplus productivity.
Why the Other Options Are Wrong
Option B: $1,360,000
$1,360,000 deducts development costs and profit but omits the $256,000 of sales and marketing entirely. Marketing is a genuine cost of converting raw land into sold lots, covering commissions, advertising, and closing expenses, and skipping it overstates what a developer could pay. The difference from the correct answer is exactly the omitted 8 percent.
Option C: $2,000,000
$2,000,000 deducts only the $1,200,000 of development costs, leaving out both the marketing expense and the profit requirement. No developer undertakes a project without a competitive return, so profit is a required deduction rather than an optional one. Ignoring both items overstates land value by nearly $900,000.
Option D: $944,000
$944,000 falls $160,000 below the correct figure, which is an extra 5 percent of gross sales, the result that follows from taking profit at 25 percent rather than the stated 20 percent. Over-deducting is just as wrong as under-deducting, and the rate must come from the problem rather than from habit. Reading the stated percentages carefully and applying each once prevents this.
Retail down to residual
Start at the top with what the finished lots sell for and subtract your way down: build it, sell it, pay the developer, and whatever is left buys the dirt. The land always gets paid last.
How to use: List gross sales first, then each deduction on its own line with the base it applies to noted. Total the deductions once and subtract once, which prevents both omissions and double counts.
Exam Tip
Check the base for every percentage. Profit stated on gross sales is a different number from profit stated on cost, and examiners rely on candidates assuming one when the problem says the other.
Common Mistakes to Avoid
- -Omitting sales and marketing or developer profit from the deductions
- -Applying a percentage to cost when the problem states gross sales
- -Deducting the same cost twice
- -Ignoring absorption and discounting in a real assignment
Concept Deep Dive
Analysis
This tests the subdivision development method, sometimes called the development or land residual approach, which values raw acreage by working backward from the retail value of the finished lots. The chain is straightforward: project the gross sales the completed lots would generate, deduct every cost required to produce and sell them, deduct the developer's required profit, and whatever remains is what a developer could rationally pay for the land. Here 40 lots at $80,000 produce $3,200,000 of gross sales. Sales and marketing at 8 percent is $256,000, the developer's profit at 20 percent of gross is $640,000, and development costs are $1,200,000, so total deductions are $2,096,000 and the residual land value is $1,104,000. Two disciplines matter: percentage-based deductions must be applied to the base the problem specifies, here gross sales, and in a real assignment the cash flows would be discounted over the absorption period, which this question deliberately sets aside.
Background Knowledge
You need the subdivision development method and the order of its deductions: gross sales, less development costs, less sales and marketing, less entrepreneurial profit, equals residual land value. You should also know that percentage deductions must be applied to the base the assignment specifies, that a full analysis discounts the cash flows over the absorption period, and that the method requires support for lot prices, costs, and absorption.
Real-World Application
Evaluating a 40-lot subdivision opportunity, you support lot pricing with finished lot sales, obtain engineering estimates for streets, utilities, and grading, apply a marketing rate drawn from local brokerage practice, and use a profit requirement consistent with developer interviews. In the report you also discount the absorption schedule, which the simplified exam version omits.
More Land/Site Questions
Under which condition is the land residual technique most applicable?
Why can the same physical parcel carry different values in two assignments?
In a built-up area where no vacant land has sold for years, which approach to site value is the usual fallback?
How is entrepreneurial profit treated in the subdivision development method?
A land comparable sold 18 months ago in a market rising about 4 percent a year. What adjustment direction applies?
Why does a developer's required profit rise for a longer subdivision project?
How does holding cost enter the valuation of land bought for future development?
Excess land is best described as land that has which characteristic?
Plottage value arises in which of the following situations?
Which of the following is an off-site improvement rather than a site improvement?
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