# where is the financing cost in this example question?

THis is question ID 383490 from Kaplan’s Qbank

An investor is analyzing the purchase of a piece of farmland. The farmland is 100 acres. If the investor purchases the property, he will finance 75% and put 25% equity into the deal. The bank loan rate on the property is 4%. The investor estimates that the land can be leased to a local farmer for \$1,500 per acre per year. Additionally, he estimates that total property taxes are \$45,000 per year and the annual insurance premium is \$15,000. If the capitalization rate for similar farmland investments is 7.5%, the value of the farmland is closest to:

solution

To determine the value of the property, the annual operating profit must be calculated and then divided by the capitalization rate. The operating profit is calculated as follows:

Annual Revenue
\$150,000
(= \$1,500 per acre × 100 acres)

Less Property Taxes
− \$45,000

Less Insurance
− \$15,000

Operating Profit
\$90,000

The value of the farmland is then \$1,200,000 (=\$90,000 / 7.5%).

The question did not give us the purchasing price of the farmland, so we can completely ignore the financing cost?

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The financing costs and equity/debt ratio for the investor are irrelevant to the solution. Looks like they just threw that info in there to confuse the reader.

When determining “market value” of land you do not consider financing costs. As indicated in the problem solution, the ”capitalization rate” is calculated on the “operating income” (also referred to in the industry as “net operating income”) which is a pre-debt calculation.