In analyzing highest and best use as vacant, an appraiser determines three potential uses are legally and physically possible. Use A has an IRR of 12%, Use B has an IRR of 15%, and Use C has an IRR of 10%. If the required return is 14%, which use is financially feasible? Assume conventional cash flows, unique IRRs and the same appropriately risk-adjusted 14% hurdle for each use.
Correct Answer
A) Use B only
With the stated compatible hurdle rate and conventional cash flows, only B’s 15% IRR exceeds 14%; A at 12% and C at 10% fail. This selects feasible alternatives under the supplied criterion; it does not mean the highest IRR always maximizes land value.
Why This Is the Correct Answer
Option A is correct because only Use B's 15% IRR exceeds the 14% required return; Use A at 12% and Use C at 10% fall short. Of the financially feasible uses, the one producing the highest land value on a risk-adjusted basis would then be the highest and best use, but here only B passes the feasibility screen.
Why the Other Options Are Wrong
Option B: All three uses
Option B says all three uses are feasible. Uses A (12%) and C (10%) both fall below the 14% required return, so they fail the financial feasibility test.
Option C: Uses A and B
Option C says Uses A and B are feasible. Use B passes at 15%, but Use A's 12% IRR is below the 14% hurdle, so A is not financially feasible.
Option D: Use A only
Option D says Use A only. Use A's 12% IRR is below the 14% required return, while Use B's 15% exceeds it, so this choice excludes the one feasible use and includes a failing one.
Clear the hurdle first
A use must clear the required-return hurdle to be feasible; only then do you compare feasible uses for maximum productivity.
How to use: Use this two-step image when a question gives IRRs and a required return.
Exam Tip
Separate the feasibility screen from the maximally productive test; the question asks which uses pass the screen, not which one is best.
Common Mistakes to Avoid
- -Treating any positive IRR as financially feasible
- -Assuming the highest IRR necessarily produces the highest land value
- -Skipping the feasibility screen and jumping to maximum productivity
Concept Deep Dive
Analysis
This question tests the financially feasible step of highest and best use analysis. With conventional cash flows and the same risk-adjusted hurdle rate for each use, a use is financially feasible only if its IRR meets the 14% requirement. Compare each IRR to 14% and keep only those that pass.
Background Knowledge
In highest and best use analysis, uses that are legally permissible and physically possible are screened for financial feasibility, meaning they produce a return that meets market requirements. Among feasible uses, the maximally productive one, producing the highest land value, is the highest and best use. A higher IRR alone does not necessarily mean the highest land value.
Real-World Application
An appraiser analyzing a vacant residential parcel models three development options. Only the duplex project meets the investor return the market requires, so it is the only feasible option to carry forward into the maximally productive analysis.
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