Question

1. One investing firm is assessing an opportunity of a real estate investment. The project requires 4.5 million CAD at the beginning of the first year to start up the first complex and 1.6 million CAD at the beginning of the second year to start the second complex. Upon completion in two years, a hotel industry customer would purchase the whole project for 8.7 million CAD. If the average secure interest rate from a bank is 4%, determine the return rate of the investment.

2. One investor wants to buy an apartment for 370,000 CAD. He then wants to rent his property for 1700 CAD a month for a year and after the year sell it for 475,000 CAD. The bank guaranteed him a return rate of 3% per annum through a mutual fund investment that can be calculated monthly. This means the investor can invest the rent money in the bank. The investor wants to know what the return rate of this investment is.

Answer 1

Return rate of the investment for real estate is calculated as follows:

Cash outflow at beginning of year 1: CAD 4.5 million

Cash outflow at the beginning of year 2:

Interest amount on CAD 4.5 million at 4% = CAD 0.18 million

Additional outflow to start second complex = CAD 1.6 million

Cash outflow at the end of year 2 (beginning of year 3):

Interest amount on CAD 4.5 million at 4% = CAD 0.18 million

Interest amount on CAD 1.6 million at 4% = CAD 0.064 million

Purchase price of the whole project (cash inflow) = CAD 8.7 million

Total profit on the investments = 8.7 - (0.18+0.064) - (0.18+1.6) - 4.5

= CAD 2.176 million

Internal Rate of Return = 19%

Return rate of the investment for investor is calculated as follows:

Cash outflow at the beginning of year 1: CAD 370,000

Cash inflow during the entire year on monthly basis as follows:

Month Rent Rate of Return Total value

1 1700 3% 1,747.34

2 1700 3% 1,742.98

3 1700 3% 1,738.63

4 1700 3% 1,734.30

5 1700 3% 1,729.97

6 1700 3% 1,725.66

7 1700 3% 1,721.36

8 1700 3% 1,717.06

9 1700 3% 1,712.78

10 1700 3% 1,708.51

11 1700 3% 1,704.25

12 1700 3% 1,700.00

Total rent cash inflow at the beginning of year 2: 20,682.85

Selling price cash inflow at the beginning of year 2: CAD 475,000

Rate of return = (475,000 + 20,682.85 - 370,000)*100 / 370,000

Rate of return = 33.96%