Question

Your client has been offered the opportunity to purchase a property investment.  Given the following assumptions:

Holding period 5 years

Cost $50,000,000

Rental income $4,000,000(receivable annually in arrears and linked to inflation)

Inflation forecast 3%

Exit yield forecast 6%

Target rate of return 10%

Transaction costs 3%

i. Advise your client of the Net Present Value of the investment opportunity.

ii. Annotate your calculations with an appropriate commentary.

Answer 1

Answer to question :

Cost : Initial Cost $ 50,000,000 ($ 5 Cr)

              Transaction Cost = 3%

               Therefore total initial cost = $50,000,000 + ($50,000,000*3%)

                                                                   = $51,500,000

Holding period = 5 years

Return :

Rental Income + Value of property at the end of 5 year i.e. Disposal value of property

Calculation of present value of rental income :

Year	Rental Income in $	Present value @10%
1	4,000,000	3,636,363.64
2	4,120,000	3,404,958.68
3	4,243,600	3,188,279.49
4	4,370,908	2,985,388.98
5	4,502,035	2,795,409.53
Total	21236543	16,010,400.32

Disposal value at the end =$ 50,000,000 + Exit yield

                                                  =$50,000,000*(1.06)5

                                                =$66,911,278.88

                                                  = 66,911,279

Recovered at the end of the 5 year = Disposal value – transaction cost

                                                                   =66911279-3%

                                                                  =64,903,940

Present value of the investment property = $64,903,940/(1.10)5

                                                                                 = $40,300,241

i) NPV of the investment property

= Initial cost – Present value of (Rental Income + Disposal Value)

=51,500,000 – (16,010,400+40,300,241)

=4,810,641

NPV of the property is positive because return on the form of rental income and disposal value exceeds the initial cost of purchase of property.

ii) In the given case since NPV is positive i.e. it exceeds the initial cost of investment at the target rate of return of 10% by $4,810,641, therefore it will be beneficial for the client to invest in the property.