You are asked to present an investment analysis of a new small residential income producing property for sale to a potential investor. The asking price for the property is $1,250,000. Rents are estimated at $200,000 during the first year and are expected to grow at 3 percent per year for the next decade. Vacancies and collection losses are expected to be 10 percent of rents. Operating expenses will be 35 percent of effective gross income. A 70 percent loan can be obtained at 11 percent interest for 30 years, requiring fixed total monthly payments. The property is expected to appreciate in value at 3 percent per year and is expected to be owned for five years and then sold.

a.Calculate the investors expected before-tax internal rate of return on equity invested (BTIRR)? What does the number tell you?

b.Calculate the debt coverage ratio. What does the number mean?

c.Calculate the terminal capitalization rate? What does the number mean?

d.Calculate the NPV using a 14 percent discount rate. What does the number mean?

(Continue the previous problem.)

The investor tells you she would also like to know how tax considerations affect your investment analysis. You determine that the building represents 90 percent of value and would be depreciated over 39 years. The potential investor indicates that she is in the 36 percent income tax bracket. Capital gains will be taxed at 20 percent and depreciation recapture will be taxed at 25 percent.

a.What is the investors expected after-tax internal rate of return on equity invested (ATIRR)? Calculate and explain. How does this number compare with the before-tax IRR (BTIRR) calculated earlier? Why is it higher (or lower)?

b.Calculate the effective tax rate. What does this number mean?