Question

An investor is considering buying a rental duplex with land valued at $30,000 and the building valued at $150,000. Straight-line depreciation over 27 1⁄2 years will be taken. The investor will be actively involved in the management of the property. He is in a 30% tax bracket.

Assume potential gross income of $44,000 in year one, vacancy of 12% and Operating expenses equal to 40% of Effective gross income. Gross potential income is expected to increase by 2% each year over the holding period.

A lender will make a 20-year loan equal to 75 percent of the total value of the property at 9 percent interest with monthly payments. Assume that there is 3 percent inflation related to total property value each year the investor owns the property and that there is a 4% commission paid (selling expenses) in the year of sale.

Assume that the investor’s after tax required rate of return is 12% and will hold the property for three years. Use the 25% tax rule where: for capital gain -- (tax rate >25% use marginal tax rate of 15%); for depreciation recapture-(tax rate >25% use marginal tax rate of 25%).

Question:
41. the after tax cash flows from operation in year 2.
A. $6,631 B. $6,937 C. $7,192 D. $7,492 E. $7,641

42. the after tax cash flow from sale of the asset in year three.

A. $44,561 B. $46,856 C. $56,727

43. NPV

A. -$12,616 B. -$12,610 C. +$12,410

44. IRR

A. 22.88% B. 21.67% C. 20.34%

45. DCR for year 1

A. 1.27 B. 2.87 C. 1.59

D. $59,476 E. $62,723 D. +$12,532 E. +$12,604 D. 22.72% E. 23.11% D. 1.64 E. 1.88

Answer 1

"If you receive rental income from the rental of a dwelling unit, there are certain rental expenses you may deduct on your tax return. These expenses may include mortgage interest, property tax, operating expenses, depreciation, and repairs." - IRS

A. (c) $7,192

Depreciation rate for building	3.636%
Depreciation expense	5454

PGI Growth rate	2%
Vacancy rate (% of PGI)	12%
Operating expenses (% of EGI)	40%

Year	Interest paid	Principal repaid
1	-12047	-2528
2	-11810	-2765
3	-11551	-3025

Income Statement	1	2	3
Potential Gross Income	44000	44880	45778
(Vacancy Losses)	5280	5386	5493
Effective Gross Income	38720	39494	40284
(Operating Expenses)	15488	15798	16114
(Depreciation expense)	5454	5454	5454
Net Operating Income (NOI)	17778	18243	18717
(Mortgage interest expense)	-12047	-11810	-11551
Before tax income	5731	6432	7166
(Personal Income Tax)	1719	1930	2150
After tax income	4011	4503	5016
(Principal repayment)	2528	2765	3025
+Depreciation	5454	5454	5454
After tax Cash flows	6937	7191	7445