Question

1. You are considering the acquisition of a small office building. The purchase price is $775,000. Seventy-five percent of the purchase price can be borrowed with a 30-year, 7.50% mortgage. Up-front financing costs will total 3.00% of the loan amount. The expected cash flows assuming a 5-year holding period are as follows:

Year	NOI
1	$48,492
2	$53,768
3	$59,282
4	$65,043
5	$71,058

The cash flow from the sale of the property is expected to be $1,000,000.

1. What is the net present value of this investment, assuming a 12.00% required rate of return on levered cash flows?
2. What is the levered internal rate of return?
3. What would you need to consider if the numbers in the chart above represented before tax cash flow?

Answer 1

a) & b)	Equity Investment			Total Cash Flow	PV @ 12%	Present Value
Year		BTCF	before-tax equity reversion			at 12%
0	$  (211,188.00)			$  (211,188.00)	1.0000	$          (211,188.00)
1		$      (723.16)		$      48,492.00	0.8929	$              43,296.43
2		$     4,552.84		$      53,768.00	0.7972	$              42,863.52
3		$   10,066.84		$      59,282.00	0.7118	$              42,195.76
4		$   15,827.84		$      65,043.00	0.6355	$              41,336.00
5		$   21,842.84	$548,598.68	$    570,441.52	0.5674	$            323,683.84
				NPV (a)		$            282,187.55
				IRR (b)		39.17%
c)
If the numbers in the chart above represented before tax cash flow than debt service and before tax equity reversion would not be calculated.
Working Notes:
Loan amount (0.75 x $775,000) =	$    581,250.00
Up-front financing costs (0.03 x $581,250)	$      17,437.50
Equity investment = $775,000 - $581250 + $17437.50 =	$    211,187.50
Calculate the before-tax cash flow (BTCF) for each of the five years
Item	1	2	3	4	5
NOI	$      48,492.00	$   53,768.00	$      59,282.00	$      65,043.00	$    71,058.00
less: Debt Service	$      49,215.16	$   49,215.16	$      49,215.16	$      49,215.16	$    49,215.16
BTCF	$         (723.16)	$     4,552.84	$      10,066.84	$      15,827.84	$    21,842.84
Annual Mortgage Payment
Loan	$    581,250.00
Rate	7.50%
Period	30
Annual Mortgage Payment (PMT(7.5%,30,-581,250)	$49,215.16
Calculate the before-tax equity reversion (BTER) from the sale of the property.
Solution:
Item	Amount
Net selling price	$ 1,000,000.00
less: Remaining mortgage balance in year 5	$  (548,598.68)
Before-tax equity reversion	$    451,401.32
Remaining maortgage balance
Loan	$    581,250.00
Rate	7.50%
Period	25
PMT	$49,215.16
Remaining maortgage balance= PV(7.50%,25,-49215)	$548,598.68