Question

Suppose that you are considering an investment in an apartment building. The specifics are: - The building is four years old, has a 85 percent occupancy rate, and has an expected useful life of 25 years. Assume that this occupancy rate is expected to continue for the life of the building. - There are 130 2-bedroom units, 100 1-bedroom units, and 70 studios. - The 2-bedroom units rent for $2800 per month, the 1-bedroom units for $2000 per month, and the studios for $1200 per month. - Current rent control laws will prevent the rents from ever being raised. - The estimated annual maintenance cost for the building is $1500000 per year (this is independent of the number of apartments rented). - There is an additional estimated maintenance cost at $200 per unit per month, when each unit is rented. - There will be no salvage value to the building in 25 years, but it is estimated that it will cost 6 million dollars at that time to demolish the building as will be required in the purchase contract. (You are not purchasing the land. You will have a 25-year lease of the land, which is paid for in the purchase of the building.) - The asking price of the building is $30 million. - The tax-rate is 30%, and assume the building will be fully depreciated over its useful life. - The WACC is 9%. Develop the pro-forma income statement, compute the Operating Cash-Flows and NPV. Assume that your bossy boss wants you to do a sensitivity analysis regarding the project. He is concerned that the vacancy rate may increase by as much as 5% (occupancy will go down to 80%). Compute the NPV for this scenario (round to nearest $10,000).

Answer 1

1.)

The NPV of the investment is 3970000 (rounded to nearest 10000)

Step 1 :- computation of Net income

INCOME STATEMENT

sales [(130*2800+100*2000+70*1200)*.85*12] = 6609600

variable costs [300*200*.85*12] = 612000

Fixed costs = 1500000

Depreciation [35,000,000 / 25 ] = 1200000

EBIT = 3297600

interest = 0

EBT = 3297600

Taxes [30%] = 989280

Net income = 2308320

Step 2:-  computation of operating cash flow

Operating cash flow = Net income + Depreciation

= 2308320 + 1200000

=3508320

Step 3 :- computation of npv

Before calculating NPV we have to calculate after-tax cost of demolishing

after-tax cost of demolishing = 6000000 * (1-.3)

after-tax cost of demolition = 4200000

The NPV of the investment is positive. therefore accept the investment.

2. Sensitivity analysis ( occupancy rate = 80%)

The NPV of the investment when occupancy will go down to 80% is 1540000 (rounded to nearest 10000)

Step 1 :- computation of Net income

INCOME STATEMENT

sales [(130*2800+100*2000+70*1200)*.80*12 ] = 6220800

variable costs [300*200*.80*12] = 576000

Fixed costs 1500000

Depreciation [35,000,000 / 25 ] = 1200000

EBIT = 2944800

interest = 0

EBT = 2944800

Taxes [30% ] = 883440

Net income = 2061360

Step 2:-  computation of operating cash flow

Operating cash flow = Net income + Depreciation

= 2061360 + 1200000

=3261360

Step 3 :- computation of npv

The NPV of the investment is positive. therefore accept the investment.