Case Study: Testing Alternatives Your client, InvestGroup, requires a 15% rate of return (IRR), minimum 6% return on capital ($/$%), as well as at least $3,000,000 in value enhancement. They are considering some alternatives for an investment property they purchased two (2) years ago. They would like you to perform an analysis of the next five (5) years, assuming a sale at the end of Year 5. The property was purchased based on the following information:

Purchase price: $8,000,000

Loan amount: $6,400,000 (80% LTV)

Interest rate: 8.75% (no points or fees)

Loan term: 30 years

Analysis begin month: 25 (purchased 24 months ago)

Going-in capitalization rate: 8.0%

Going-out capitalization rate: 10.5%

Cost of sale: 3.5% As-Is (Alternative One)

Figures for the Pro Forma Statement include (Year 1*): *You can enter data directly on the Pro Forma Statement tab, Year 1 column.

Gross Potential Income (GPI): $1,800,000 Based on lease escalations, GPI is expected to increase 5% per year. Vacancy and Collection Loss: 2% of GPI, also expected to increase 5% per year. Operating Expenses: 1) Heat = $87,350, 2) Electric = $51,775; 3) Water = $75,875; 4) Landscaping = $44,125; 5) Maintenance Labor = $118,750; 6) Insurance = $187,125; 7) Real Estate Taxes = $200,000; and 8) Management Fee = 4% of Net Rent Revenue Expenses are expected to increase by 2% per year (apply increase % to each expense).

What is midstream current equity?

What is midstream current market value?

What are the before-tax cash flows for the next five years?

What are the net sales proceeds at the end of the holding period? Perform the Four Tests of Investment Return. $/$%: ____________ Value Enh: ____________ NPV: ______________ IRR: ____________

Alternative Two :

After discussions with the owners, you decide to test the feasibility of an alternative course of action: Perform a moderate renovation of common areas at a cost of $150,000 as well as a moderate upgrade of the common exterior and landscape area at a cost of $50,000, for total capital improvements (CAPEX) of $200,000. Based on your survey of comparable properties and your analysis of the supply, demand, and absorption statistics, you conclude that the combination of these projects will increase the GPI by 7% per year (instead of 5%) starting next year. Vacancy and Collection loss is expected to remain the same at 2% of GPI (with 5% annual increase). Expense escalations are projected to remain the same (2% annual increase).

What is midstream current equity?

What is midstream current Market Value?

What are the before-tax cash flows for the next five years?

What are the net sales proceeds at the end of the holding period?

Perform the Four Tests of Investment Return. $/$%: ____________ Value Enh: ____________ NPV: ______________ IRR: ____________

Alternative Three:

After discussions with the owners, you decide to test the feasibility of another alternative course: Perform an upgrade to the energy consuming equipment at a cost of $100,000 (CAPEX). Because of the installation of the energy saving equipment, you expect that the operating expenses will only increase by 1% annually instead of the 2% originally projected. GPI in this case is projected to increase by the original 5% per year.

What is the midstream current equity?

What is midstream current market value?

What are the before-tax cash flows for the next five years?

What are the net sales proceeds at the end of the holding period?

Perform the Four Tests of Investment Return. $/$%: ____________ Value Enh: ____________ NPV: ______________ IRR: ____________

MAKE A RECOMMENDATION Your analysis test results should align with the answers in the matrix below for the three alternatives.

TEST Alternative 1 (As Is)

Alternative 2

Alternative 3

$/$% 6.62% 6.36% 6.49%

Value Enhancement $1,052,071 $3,014,702 $1,372,393 NPV ($272,278) $798,322 ($120,046) IRR 13.50% 18.84% 14.36%

1. Based on your analysis and understanding of the investment goals, which alternative would you recommend to the owners? Why?

2. Explain what each investment return metric means, as if you were explaining the results to your client/investor:

a. $/$%

b. Value Enhancement

c. NPV

d. IRR