NPV, IRR, Cap Rate Questions

CFA Level II Alternative Investments
#1

Hi there,

Could someone kindly help me answer the following questions?

  1. If a project has zero NPV and the discount rate is 12% than what is the IRR?
  2. When calculating the IRR of an investment, should you include debt service?
  3. If you have an LTV of 75%, a cap rate of 4% and a 3% interest rate, what is your ROE?
  4. What is the amortizing loan constant for a 6% 30-year mortgage on a $50 million dollar loan

Many thanks,

Jamie

#2

  1. 12%, IRR is the return to zero NPV for a series of cash flows

  2. Yes, you should include the debt service (I believe, 80% positive here, hopefully someone else chimes in)

  3. Net Income/Equity. You only have 25% equity, so that is your denominator… Net Income for a property is calculated as NOI, which would be NOI/PP = Cap rate. If you just use 100 as the PP, ROE should be around 16%.

  4. Not familiar with amortizing loan constant, sorry.

#3

In regards to #2 I think Debt service costs aren’t included. I remember reading to assume that projects are all equity funded. Not sure if that was for a specific type of project or what.

#4

We don’t include debt service because we want to know the true performance of the project, so we assume it is 100% equity funded.

Including debt in a project will most likely increase profitability because after-tax cost of debt is generally lower than investor cost of equity.

#5

Definitely exclude debt service.

Thinking about it like this - when you are calculating NPV, you use WACC (weighted average cost of capital), which includes your cost of debt.

As such, same would apply to calculating IRR as per the answer to your first questions since “NPV at 12% being nil” = 12% IRR.