Farmland on a city's edge is expected to convert to residential use in six years. The present worth of net farm income over those six years is $90,000, and the present worth of the residential land value at conversion is $1,150,000. The old farm buildings will then be removed, and the present worth of removal cost in excess of salvage is $40,000. What is the total market value?
Correct Answer
B) $1,200,000
Transitional property value is the present worth of interim benefits, plus the present worth of the succeeding use, less the present worth of removal cost when it exceeds salvage: $90,000 + $1,150,000 - $40,000 = $1,200,000. Omitting the interim farm income gives $1,110,000, ignoring the removal cost gives $1,240,000, and adding the removal cost instead of deducting it gives $1,280,000.
Why This Is the Correct Answer
Option B is correct because $90,000 of interim farm income plus $1,150,000 for the future residential land, minus $40,000 of net removal cost, equals $1,200,000. Each piece is already at present worth, so they can be added directly.
Why the Other Options Are Wrong
Option A: $1,110,000
Option A, $1,110,000, is $1,150,000 - $40,000 and leaves out the $90,000 present worth of farm income. The interim use produces income above expenses, so it adds to current value.
Option C: $1,240,000
Option C, $1,240,000, is $90,000 + $1,150,000 and ignores the $40,000 net removal cost. Clearing the farm buildings will cost more than their salvage, so that cost reduces value.
Option D: $1,280,000
Option D, $1,280,000, adds the $40,000 removal cost ($90,000 + $1,150,000 + $40,000). A cost in excess of salvage is a negative present worth and must be deducted.
Interim plus future minus cleanup
Add what the land earns while it waits, add what it will be worth when it converts, and subtract what it costs to clear away the old use.
How to use: Use this sign check whenever a transitional-property question gives you salvage or removal figures.
Exam Tip
Watch the sign of the removal item: salvage adds, removal cost in excess of salvage subtracts. Confirm whether figures are already discounted before discounting again.
Common Mistakes to Avoid
- -Leaving out the interim income
- -Adding removal cost instead of deducting it
- -Discounting figures that are already stated at present worth
Concept Deep Dive
Analysis
The question applies the three-part formula for a property in transition. All three figures are already present worths, so the work is to combine them with the correct signs: interim income adds, the succeeding use adds, and removal cost in excess of salvage subtracts.
Background Knowledge
An interim use contributes to value when its income exceeds its operating expenses. When interim improvements must be removed at the end of the interim period, their salvage value adds to present value, or the removal cost subtracts if it exceeds salvage.
Real-World Application
An appraiser values a 40-acre farm in the path of suburban growth for an estate. The farm still earns crop-share rent, residential absorption is expected in about six years, and old barns will need demolition, so the appraiser combines the discounted rent, the discounted future lot value and the discounted net demolition cost.
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