Question

You have recently graduated from school and have started your new job at a Consulting LLC. You have been given the following assignment. You are to present an investment analysis of a new residential income producing property an investor is considering purchasing. The asking price for the property is $1,200,000; rents are estimated at $201,000 during the first year and are expected to grow at 3.5% per year thereafter. Vacancies and collection losses are expected to be 11 percent of rents. Operating expenses will be 35% of effective gross income. A 70% loan can be obtained at 11% interest for 30 years. The property is expected to appreciate in value at 3% per year and will be sold in 5 years. You determine that the building represents 90% of value and would be depreciated over 39 years (use 1/39th per year). The potential investor indicates that she is in the 36% tax bracket and has enough passive income from other activities so that any passive losses from this activity would not be subject to any passive activity loss limitations. Capital gains from price appreciation will be taxed at 20% and depreciation recapture will be taxed at 25%. The discount rate is 14%. What is the investor’s expected before-tax internal rate of return on equity invested (BTIRR)?

What is the investor’s expected after-tax internal rate of return on equity invested (ATIRR)?

What is the first year debt coverage ratio?

What is the terminal capitalization rate?

*There is no balance sheet given in this problem*

Answer 1

Loan Amount	70% X Propoerty price
	840000
	Cash Flows
		Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Property price		1200000	1236000	1273080	1311272	1350611	1391129
Loan		840000
Purchase Price		1200000
Rent			201000	208035	215316.2	222852.3	230652.1		(Rents growing at 3.5%)
Vacancies and collection losses			22110	22883.85	23684.78	24513.75	25371.73		(11% of rent)
Operating Expenses			70350	72812.25	75360.68	77998.3	80728.24		(35% of rent)
Depriciation			27692.31	27692.31	27692.31	27692.31	27692.31		(90% X 1200000/39)
Interest			92400	92400	92400	92400	92400		(11% X loan amount)
PBT			10557.69	15130.44	19863.24	24761.68	29831.57
Tax			3800.769	5446.959	7150.766	8914.206	10739.37		(36% X PBT)
PAT			6756.923	9683.483	12712.47	15847.48	19092.21
Capital gain							329590.4		(Property price in year 5 - (Purchase price-Total Depriciation upto 5 years))
After tax capital gain							247192.8		(Tax = 25% X Capital gain)
Cash Flows before tax	PBT +Dep-Capital Expenditure +Net borrowings+Capital gain
		-360000	38250	42822.75	47555.55	52453.99	387114.3
BTIRR before tax		12%
Cash Flows after tax		PAT +Dep-Capital Expenditure +Net borrowings+ after tax Capital gain
		-360000	34449.23	37375.79	40404.78	43539.78	293977.3
BTIRR after tax		6%