P Corp bought an office building for $6,500,000 5 years ago with the purpose of renting as a residential area. The assumptions are:

First-year potential gross income of $1,200,000 with a 3.2% annual growth rate

Vacancy & collection losses equal to 12% of PGI

Operating expenses:

First-year insurance of $145,000 with a 2.5% annual growth rate

First-year Utilities of $137,000 with a 2% annual growth rate

First-year Maintenance Expense of $75,000 with a 1.5% annual growth rate

Capital expenditures = 4% of EGI with a .5% annual escalation

70% LTV at 6%

The mortgage will be amortized over 25 years

Total up-front financing costs:

2 points of the loan amount

$1000 appraisal fee

Calculate After Tax Cash Flows including After Tax Equity Reversion taking into account the following assumptions:

80% of the original cost is allocated to depreciable real property. The cost recovery period is 27.5 years.

P Corp is in the 30% tax bracket on ordinary income

If P Corp were to sell the property at the end of year 5, assume the sale price equals the year 6 NOI capitalized at 10% and selling costs equal 5% of the sale price

Capital gains tax rate = 20%

Depreciation recapture tax rate = 25%

Calculate After Tax NPV and IRR. Similar properties use a 6.5% discount rate.

Did P Corp make a good choice by investing in this property?