GIVEN EXAMPLE ON GENERATING CASH FLOWS, EQUITY REVERSION AND NPV IRR ANALYSIS Purchase Price $525,000 Land Value : $74,000 30 yr. fixed rate loan @8% : $393,750 Loan to Value ratio : 75% 1st yr. Potential Gross Income: $108,000 Average VCL 4% 1 st yr. Other Income 1st yr. Operating Expenses : $39,680 Yearly NOI increase : 5% Yearly OE increase 5% Ordinary income tax rate 36% Tax on Recaptd. Deprectn. 25% Tax on Capital Gain 20% Required Rate of Return : 12% Selling costs 7% Capitalization Rate 10% Assumptions: 1. No Half Month (depreciation) Convention used for 1st year 2. Overall CapRate available from comparable properties to determine the sales price is REQUIRED: A. Construct detailed cash flows for the years 1 to 4, showing the BTCF and ATCF for each year. B. Based on the available CapRate from comparable properties and the projected NOI for the 5th year, calculate the BTER and ATER, if this property were to be sold at the end of 4th year. C. Based on your initial equity, projected cash flows and equity reversion, perform a Net Present Value analysis and calculate the Internal rate of Retum for this property. Based on your NPV and IRR findings, is this a good investment? SOLUTIONS A. EXAMPLE ON GENERATING CASH FLOWS, EQUITY REVERSION AND NPV IRR ANALYSIS What is formula? DESCRIPTION INCOME YEARS ($) 2 3 4 Gross Potential 108,000 113,400 119,070 125,024 131,275 VCL 4,320 Effective Gross 103,680 4,536 108,864 4,763 5,001 114,307 120,023 5,251 126,024 Other Income 0 Total Effective Income 103,680 108,864 114,307 120,023 126,024 EXPENSES Variable Fixed Total Expenses 39,680 41,664 43,747 45,935 48,231 Net Operating Income 64,000 67,200 70,560 74,088 77,792 TAX CALCULATIONS NOI 64,000 67,200 70,560 74,088 77,792 Annual Debt Service 34,670 34,670 34,670 34,670 34,670 End of year OLB 390,461 386,899 383,041 378,862 374,338 Cumulative Principle paid 3,289 6,851 10,709 14,888 19,412 Yearly paid Interest 31,381 31,108 30,812 30,491 30,146 Yearly Allowed Depreciation 16,400 16,400 16,400 16,400 16,400 Taxable income for the year 16,219 19,692 23,348 27,197 31,246 Tax @36% 5,839 7,089 8,405 9.791 11,249 BTCF 29,330 32,530 35,890 39,418 43,122 ATCF 23,491 25,441 27,485 29,627 31,874 ROE after taxes 17.90% 19.38% 20.94% 22.57% 24.28% B. BTER @ DISPOSAL Year 5 NOI Assumed CapRate EXAMPLE ON GENERATING CASH FLOWS, EQUITY REVERSION AND NPV IRR ANALYSIS Gross Sales Price (NOI/CapRate) Closing Expenses Net Sales Price Mortgage Balance Before Tax Equity Reversion ATER @ DISPOSAL Purchase Price (including Exp.) formula Accumulated Depreciation (for 4 yrs.) Adjusted Base Price (Purchase Price - Acc. Depreciation) Gain Realized on Sale (Net Sales Price - Adjusted Basis) Recognized Gain at sale (Realized Gain - Acc, Depreciation) Capital Gains Tax @ (tax on recognized gain) Recaptured Depreciation Tax Total Taxes @ Disposal ATER (BTER - Taxes @ Disposal) this amount to be added to 4th year cash flow C. NPV & IRR for PROJECTED CASH FLOWS 77,792 10% 777,924 54,455 723,469 378,862 344,607 525,000 65,600 459,400 264,069 198,469 39,694 16,400 56,094 288,513 YEARS ($) DESCRIPTION 1 2 3 Initial Equity (down payment) ATCF (131,250) 23,491 25,441 27,485 318,141 20,974 20,281 19,563 202,184 Present Value of Cash Flows 263,003 Net Present Value 131,753 IRR 37% NPV > 0 and IRR is almost 3 times the RRR: This is a good investment within the given parameters.