The income approach to real estate valuation values property using a perpetuity discount type of model. The perpetuity is the annual net operating income (NOI). This perpetual stream is discounted at a market rate of return.

Required:

Determine the first year's after-tax cash flow using the following data:

Net operating income (NOI) for first year

Shs. 83, 800

Straight-line depreciation

Shs. 18,700

Mortgage payment

Shs. 59, 404

Purchase price

Shs. 700,000

80% financing at a 10% interest rate

NOI growth rate

5%

Marginal income tax rate

31%

Determine the second year's after-tax cash flow, using the preceding table and with a growth rate of 5% in NOI.

The property is sold at the end of the fifth year. Determine the after-tax cash flow that property sale year, using the following data (the after-tax cash flow without property sale has been calculated as previously).

After-tax cash flow without property sale

Shs. 33,546

Straight-line depreciation

Shs. 18,700

Mortgage payment

Shs. 59,404

Cumulative mortgage principal payments by end of fifth year

Shs. 20, 783

Purchase price

Shs. 700,000

80% financing at 10% interest rate

NOI growth factor

5%

Marginal income tax rate

31%

Capital gains tax rate

20%

Forecasted sales price

Shs. 875,000

Property sales expense as a percentage of sales price

6%

Use the information below to answer parts (d).

The following data summarize the after-tax cash flows for all five years of the project's life.

Year

1

2

3

4

5

Cash flow

21,575

24,361

27,280

30,339

273,629

The analyst now turns to evaluating whether the project should be undertaken. She estimates the required rate of return for an equity investment in projects of similar risk as 16%. The purchase price for the property is shs. 700,000. The financing plan calls for 80% debt financing, so the equity investment is only shs. 140,000. The investor's cost of equity for projects with this level of risk is 16%.

Determine the real estate project's NPV, using the analyst's required rate of return, and make a purchase recommendation based only on this analysis.