NPV Question!!

Hi all, I have a specific question that I can’t solve. Since I’m not allowed to post any questions here, what can I do to get some help on how to solve this problem? Any ideas?

rezje Wrote: ------------------------------------------------------- > Hi all, > > I have a specific question that I can’t solve. > Since I’m not allowed to post any questions here, > what can I do to get some help on how to solve > this problem? Any ideas? Isn’t that 2 questions posted already? Oh crap, now I posted a question. How do I delete a question I just posted? Oh double crap.

I loled? Sh!t.

you can ask a specific question, just not one from the cfa exam.

Ok. Well this is a question I have to answer for school. So if you could give me any insight, I would appreciate it. Based on these estimates calculate the NPV of this project at a 10% discount rate. *Purchase Price: \$2.5 million *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. The prospective purchaser is in the 35% marginal income tax bracket.

Rezje- Just cranked out what I’m about 95% sure is the answer in excel. Almost anyone who’s studied and sat for the exams can walk you through this, but first let’s see some work from you. Show us your calculations for years 1, 2, and the final sale proceeds as best you can. More than happy to help, but don’t just dump the problem on the forums without showing us you’ve taken a swing at it, brosef.

Maybe it’s a sign of the times now that I’ve retired the books, but I gave it a shot in excel, and while I’m in the ballpark, there’s a few things I need clarified. 1) Are the annual payments for the debt (\$234,919) amortizing? And this number includes both principal and interest correct? Because I put together an quick amortization schedule and it appears that the debt would be payed off plus a little in 19 payments. Although, it is possible that I messed up, I am rustier than a trombone. 2.) The taxes in the “maintenance and taxes” expense are property, etc and not income taxes, correct (otherwise why bother with the depreciation expense and the 35% rate at the bottom since the exit price is after tax)? 3.) If we assume those taxes in #2 are not income taxes, then interest but not principal would be pretax, correct? If so, #1 needs to be clarified. Anyhow, if you can clarify that for me and show me some work I’d be glad to offer more input regarding the steps / solution.

rezje is a cute n00b.

CF0: -500,000 CF1: [(300,000-234,919-35,000-60,000)*(1-.35)]+60,000 = 40,552 CF2: [(300,000-234,919-35,000-60,000)*(1-.35)]+60,000 = 40,552+610,000=650,552 NPV @10% = 37,646.82

Art, pretty sure principal isn’t pretax.

artvandalay Wrote: ------------------------------------------------------- > CF0: -500,000 > CF1: > [(300,000-234,919-35,000-60,000)*(1-.35)]+60,000 = > 40,552 > CF2: > [(300,000-234,919-35,000-60,000)*(1-.35)]+60,000 = > 40,552+610,000=650,552 > > NPV @10% = 37,646.82 I’ma roll with this answer as well (at least, that’s how I’d calculate it).

Black Swan Wrote: ------------------------------------------------------- > Art, pretty sure principal isn’t pretax. What? Not sure what you are getting at? Are you talking about the 500,000 down payment? That wouldn’t be taxed. If you are talking about the 610,000 net proceeds, it says that’s after tax already.

The \$234,919 annual payment on the \$2m loan is principal plus interest

I think he is referring to the \$235K annual payments on the debt. Only the interest portion of these payments would be deductible for tax, whereas your NPV calculation implicitly assumed that the entire amount is deductible.

Art- I can’t tell by the way you wrote it, but I don’t think you accounted for the fact that the payment covers two pieces. One is interest, one is principal. Year one, the mortgage balance is 2 million. The payment is \$234,919. Of this payment, some is interest, some is principal. Remember that ONLY INTEREST is tax-deductible. Principal will go towards reducing the balance in year two. From your equations, I think you may not have broken down the pymts into their component parts, which you need to do for tax purposes. I could keep going, but again, I’d like to see some effort from the OP before I just throw the answer and methodology up here.

artvandalay Wrote: ------------------------------------------------------- > Black Swan Wrote: > -------------------------------------------------- > ----- > > Art, pretty sure principal isn’t pretax. > > > What? Not sure what you are getting at? Are you > talking about the 500,000 down payment? That > wouldn’t be taxed. If you are talking about the > 610,000 net proceeds, it says that’s after tax > already. Ok, the debt is at 10%, right? On \$2MM, that’d only be \$200k for the first period. So obviously the difference in the debt payment is principal amortization. My point is that I don’t believe principal is a pretax expense. So therefore, you split out the two portions, principal payments get deducted after you’ve taxed your income to arrive at FCF for each period. It’s a small difference, but a difference. So for CF1: CF1: [(300,000-200,000-35,000-60,000)*(1-.35)]+60,000 - 34,919 = 28,331 Also, because of the way you calculated the CF1, including principal, you were at a loss before you multiplied by (1- tax rate), thus reducing your loss. It does not work this way, the government will not send you a check at the end of that year since you had a loss. You could only carry that loss forward and hope to cash in on it through a carefully structured sale or via deductions future profitable period. At which point, the cash from the tax shelter would be realized and discounted from said future period. Since the sales number is net of taxes, we must assume that any tax impacts carried forward from the losses were factored in there. The end result is that it is not correct to simply multiply a negative number by (1-t) to arrive at FCF because the govt won’t be cutting you some check that period. However, if you break out principal and interest separate (why else would they mention a 10% interest rate) then the whole issue becomes null since your pretax income is positive.

BTW, the OP does suck, he gets no more freebies from me after this thread. I just thought I’d try my hand and see if I still got it.

Ah I see what you’re saying, principal and interest need to be broken out for the tax calc - agreed. I didn’t look at the question very closely.

OP, Hope YOU did well on YOUR homework.

supersadface Wrote: ------------------------------------------------------- > Rezje- > > Just cranked out what I’m about 95% sure is the > answer in excel. Almost anyone who’s studied and > sat for the exams can walk you through this, but > first let’s see some work from you. Show us your > calculations for years 1, 2, and the final sale > proceeds as best you can. > > More than happy to help, but don’t just dump the > problem on the forums without showing us you’ve > taken a swing at it, brosef. Yr. 0 Yr 1. Yr. 2 Rent revenue \$300,000.00 300,000.00 Maintenance and Taxes (35,000.00) \$(35,000.00) Net Operating Income \$265,000.00 \$265,000.00 Debt Service \$234,919.00 \$234,919.00 Cash Flow Before Taxes \$30,081.00 \$30,081.00 Ppal Amt. \$34,919.00 38,410.90 Depreciation (60,000.00) \$(60,000.00) Cash Flow Before Taxes \$5,000.00 \$8,491.90 Taxes \$1,750.00 \$2,972.17 Cash Flow After Taxes \$3,250.00 \$5,519.74 Balance Owed, beg. Year. \$2,000,000.00 \$1,965,081.00 Annual Mortgage Pmt \$234,919.00 \$234,919.00 Int. Portion of Pmt. \$200,000.00 \$196,508.10 Amt. of Principal \$34,919.00 \$38,410.90 Balance Owed, end. Year \$1,965,081.00 \$1,926,670.10 When I calculate NPV with these numbers I get: CF0 = -500,000 CF1 = 3,250 CF2 = \$ 5519.74 CF3 = 610,000 NPV = -34,181.65 I’m not sure about the calculation of sale proceeds you asked for. If you could give me a little insight if I’m in the right path, I would appreciate it. Thank you. P.S. Thanks to all of the other posts as well. Even though I don’t appreciate the sarcasm and insults of some other people, still I appreciate it. I couldn’t post yesterday due to time constraints.