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Chapter 10 homework question 1. What is the relationship between the ex ante return on an investment and the price for the asset paid by the investor? 2. What is the greater fool theory? How can the multiperiod DCF valuation procedure help to protect investors from falling victim to this theory? 3. What is the relationship between the discount rate that should be used in the DCF procedure and the cash flows that are being discounted? 4. When is the most important to \"unbundle\"a property's cash flows to apply different discount rates to different cash flow components? 5. What is wrong with the following statement: Property X is worth $ 10 million in the market today because it produces $1 million of annual net income, and cap rates in the relevant property asset market are currently 10 percent. 6. What is meant by the term GIGO in reference to the practical application of the DCF valuation procedure for commercial property? What are some typical mistakes in the numerators? What about in the denominators? 7. What is the approximate relationship among the cap rate, the discount rate , and the long-run average growth ate in property cash flow and value? 8. Starting with your answer to Question 7, write the investor's required return as the sum of the risk-free rate plus a risk premium to establish to establish the approximate relationship between the cap rate, interest rate, risk premium and growth rate in property cash flow. Then answer the following question: a. How are cap rates affected by interest rates? Does an invrease in the risk-free rate imply higher cap rates? (hint: there is no mention of \"all else equal.\") b. Many analysts have taken to defining the spread between the cap rate and the risk free rate as a risk premium. What is wrong with this practice? Under what conditions does this lead to the perception of a high-risk premium being incorporated into property values, when in fact the opposite is true? 9. What is wrong with the following statement: investors typically overstate both the numerators and denominators in applying the DCF approach to commercial property, with the two types of errors largely canceling each other out, so that there is really no harm done by this type of mistake. 10. What fundamental principle underlies the NPV investment decision rule? ( Hint: what is the relation between NPV and the investor's wealth) 11. Why is a zero-NPV deal OK? Where is the profit for the investor in a deal in which NPV=0? 12. Why is the NPV of the typical deal zero when evaluated from a market value perspective? 13. Describe at least two other considerations besides NPV that can allow investors to choose among alternative investments that have the same NPV. 14. Describe at least two problems that can be encountered in using the hurdle rate version of the NPV investment decision rule, and how those problems can be resolved? 15. Consider a property with expected future net cash flows of $25,000 per year for the next five years (starting one year from now). after that, the operating cash flow should step up 20 percent, to $30,000, for the following five years. If you expect to sell the property 10 years from now for a price 10 times the net cash flow at the time, what is the value of the property if the required return is 12 percent? 16. In the previous question, suppose the seller of the building wants $260,000. a) Should you do the deal? Why or why not? ( Hint: what would be the net present value of the deal for the buyer at $260,000?) b) What is the IRR if you pay $260,000? How does this compare to the required return of 12 percent? c) What is the IRR if you could get the seller to accept $248,075 for the property? What is the NPV at that price