Challenging NPV problem

CFA Level I
#1

Real estate investment from past mock exam:

Purchase price: 2.5 milion

Down payment is $500,000, financing at 10%, with 20 annual end of year payments of 234,919 each.

Gross annual rents are 300,000

Depreciation is 60,000 per year

Maintenance and taxes are 35,000 per year.

The building will be sold at the end of 2 years, producing net after tax proceeds of 610,000 after the loan balance is repaid. Millers client, the prospective purchaser, is in the 35% marginal income tax bracket.

The NPV of this project at a 10% discount rate, based on these estimates is closest to:

a) -19,000

b) 28,000

c) 52,000

d) 64,000

#2

Wonder how they got $234,919? 10% of 2M = 200k. I don’t suppose we subtract 200k on top of the $234,919.

This is also unclear to me, are these property taxes like council rates?

#3

pv = 2,000,000 i = 10% n = 20 pmt -> 234,919

#4

yes Cheswick, you are correct; what do you think about the cash flows? I am having trouble in making the 2nd year cash flow

#5

First off, this question is far more complicated than anything you’d find on a level 1 exam, and quite frankly more poorly written. I assume maintenance and taxes is referring to some sort of property tax.

Intial outflow, cf0: -500,000

Year one: Income tax: (300,000 - 60,000 - 2M*.1 - 35,000) *0.35= 1750

CF1: 300,000 - 35000 - 234919 - 1750 = 28331

Remaining principal for year 2: 1,965,081

Year two tax: (300,000 -60000 - 196508 - 35000) * 0.35 = 2972

cf2: 300,000 - 35 000 - 234 919 - 2972 + 610000 = 637109

NPV @ 10% = 52,292

#6

Thank you!!! Yes, this was very confusing and challenging.

#7

Thanks cheswick, I interpreted 10% as a coupon payment on a bond. Will have to think about it some more as I’m obviously confused somewhere.

This was my first impression also.

On the exam, you won’t have answers that are off by this much to your calculations.