# Level I Volume 6 Real Estate After-tax Cash Flow

Hi, I’m going through the Volume 6 content and spent quite some time to understand the after-tax cash flow topic. Can anyone help me with the following questions? P. 243 No. 25 (2005 CFA Exam): I thought the answer should be B. Instead the answer sheet says A. If you worked thoroughly on the P. 238 No. 6 which is a quite similar problem, you’ll see the following year’s after-tax cash flow is actually increasing (comparing the calculating results at A-18 answer sheets). After-tax Cash Flow = After-tax Net Income + Depreciation - Principal Repayment Assuming every other components are constant, the interest payment will decrease year after year, that means after-tax net income will increase, so does the principal repayment. The overall after-tax cash flow should increase, right??? ************************************************************************ One more 2005 CFA Exam question. P. 244 No. 28: I don’t know how the answer was calculated. Mine is slightly different. Estimated payoff = \$12 Million x Survival Rate 15% = \$1,800,000 Present Value = \$1,800,000 / (1 + 17%)8 = \$512,820 (I don’t know how to type exponent) Then, NPV = PV - Initial Investment = \$1,800,000 - \$512,820 = \$112,820 The answer is \$112,608. Can you point out what I did wrong? Besides this discrepancy, I’m a bit confused with the method the answer sheet used. Do you think the estimated payoff \$12 million should deduct the initial investment first, and then times the probability of survival? The example in the book said so. And what about the failure probability 85% and max loss \$400,000? The answer seems not considering this factor. Apprciate if any master can clarify. Thanks. -Hui

One more 2005 CFA Exam question. P. 244 No. 28: I don’t know how the answer was calculated. Mine is slightly different. Estimated payoff = \$12 Million x Survival Rate 15% = \$1,800,000 Present Value = \$1,800,000 / (1 + 17%)8 = \$512,820 (I don’t know how to type exponent) Then, NPV = PV - Initial Investment = \$1,800,000 - \$512,820 = \$112,820 The answer is \$112,608. Can you point out what I did wrong? Hui you seem to be making some sort of calculation mistake on this one. 1800000/1.17^8 = 512608. 512608 - 400000 = 112608 --> Book answer. Please check your calculations.

You need to post the question…and we will give you the answer

Thanks, cpk123. However, 1.17^8 = 3.51 --> 1800000/3.51 = \$512,820 How did you get \$512,608??? In addition, why the answer ignore the failure probability? In the book example, it seems always probability-weighted to calculate NPV. Thanks. *********************************************************************** strangedays, thanks for your help. P. 243 No. 25 (2005 CFA Exam): An investor is considering the purchase of an apt building. The investro expects the NOI remain constant over the life of the investment. The investor plans to depreciate the property using straight-line depreciation and expects that his 35% tax rate will not change over the life of the investment. The investor will finance 80% of the purchase price with a long-term mortgage loan that will require a level annual payment of \$62,600, and he intends to hold the property for at least 10 years. During teh years prior to the sale of the property, the investor’s annual after-tax cash flow from the investment will most likely: A. be lower in the third year than in the second year. B. be higher in the third year than in the second year. C. remain constant, because NOI is expected to remain constant. D. remain constant, because the cash inflows and outflows are expected to remain constant. I sure can rid of C, D right away. But from the after-tax cash flow formula, can you tell me why A is correct? After-tax Cash Flow = After-tax Net Income + Depreciation - Principal Repayment Assuming every other components are constant, the interest payment will decrease year after year, that means after-tax net income will increase, so does the principal repayment. The overall after-tax cash flow should increase, right???

Yes, the interest payment will decrease year after year, but on the other hand the principal repayment, which is deducted in the computation of cash flow, will increase each year. This increase of the principal repayment will offset the decrease in interest due to the tax effect in the computation of net income and therefore make the after tax cash flow decrease each year. At least I think that A is the answer. Everybody, am I right?

Hi, thanks for your analysis. However, please re-check P. 238 #6 (at Volum 6) and comparing the calculating results at A-18 answer sheets, you’ll see the following year’s after-tax cash flow is actually increasing, not decreasing… Oh, by the way, anyone can confirm the result of: 1800000/1.17^8 = \$512,820 Some of you got \$512608. Did I calculate it wrong? Thanks, -Hui

hyang Wrote: ------------------------------------------------------- > Hi, thanks for your analysis. > > However, please re-check P. 238 #6 (at Volum 6) > and comparing the calculating results at A-18 > answer sheets, you’ll see the following year’s > after-tax cash flow is actually increasing, not > decreasing… > > Oh, by the way, anyone can confirm the result of: > > 1800000/1.17^8 = \$512,820 > > Some of you got \$512608. Did I calculate it > wrong? > > Thanks, > > -Hui You are getting \$512,820 due to rounding…if you use the inverse function on the calculator, you will get 512,608…

Sorry, I still did not get it… Why should I use Inverse Function to calculate this? Wrong??? 1.17^8 = 3.51 --> 1800000/3.51 = \$512,820 Thx, Hui

hyang Wrote: ------------------------------------------------------- > Sorry, I still did not get it… > > Why should I use Inverse Function to calculate > this? > > Wrong??? 1.17^8 = 3.51 --> 1800000/3.51 = > \$512,820 > > Thx, > > Hui IT’S THE ROUNDING! The rounding makes the difference! you don’t HAVE to use the inverse calculation… 1800000/(1.17^8) will give u the correct ans.

Thanks for your patience, delta9. I’m the idiot… 1.17^8 = 3.51145328 1800000/3.51145328 = 512608.27 The more than 200 difference of this rounding fooled me. Thx much. I’m so stubbon.

don’t worry about it…so close to the exam i think we’re all on the edge…need to breathe!!!

petrca Wrote: ------------------------------------------------------- > Yes, the interest payment will decrease year after > year, but on the other hand the principal > repayment, which is deducted in the computation of > cash flow, will increase each year. This increase > of the principal repayment will offset the > decrease in interest due to the tax effect in the > computation of net income and therefore make the > after tax cash flow decrease each year. At least I > think that A is the answer. > > Everybody, am I right? yeah , it is A. you nailed it