Fletcher Miller is analyzing a real estate investment: - Purchase price 2,500,000 - Down payment 500,000, financing at 10%, with 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 The building will be sold at the end of year 2, producing net after tax proceeds of 610,000 after the loan balance is repaid. Miller’s client, the prospective purchaser, is in the 35% marginal income tax bracket. The NPV of this project is closest to: a) -19,000 b) 28,000 c) 52,000 d) 64,000

where is the discount rate for NPV?

I would it’s 10% because it’s cost of capital very good questions by barthezz

I wouldn’t assume it’s the cost of financing (this is cost of debt btw…) the required rate of return for the specific project incorporates the risks associated with the specific project, and it maybe not be included in this cost of financing…

That’s what I understood that the IRR has to be at least as big as the cost of capital which in this case is the cost of financing

ok for the inflow cash flow= (revenue-costs)*(1-t)+depreciation*t = (300000-35000)*0.65+60000*0.35 = 193250 do you guys think it’s correct so far?

yeah, except add interest paid on loan as an expense as well

Yes that is what i thought seems to complicated to solve one problem this is out of my league at this time

I’ll go with C, 52,000 (I’ll probably skip this que in the exam) After tax cash flows yr 0: (-) 500,000 yr 1: 28,331 yr 2: 27,108 + 610,000 = 637,108 i = 10% NPV --> 52,290 1st year CF = [300,000 - 200,000 ($2M*10%) - 60,000 - 35,000] * 0.65 = 3,250 Add back Depreciation (60,000), and subtract principal payment (234,919 - 200,000) 3,250 + 60,000 - 34,919 = 28,331 Loan outstanding at the end of year 1 = 2,000,000 - 34,919 = 1,965,081 2nd year CF = [300,000 - 196,508 - 60,000 - 35,000] * 0.65 + 60,000 - 38,411 (234,919 - 196,508) = 27,108 Also building sold for 610,000. Is that the right answer?

Good question i agree… as a matter of fact we had a similar question in June and lets crack it

Agree with delhirocks…Ill go with C as well.

C is correct.

good job dehlirocks

Why was principal payments subtracted - ? to get to CFO? delhirocks Wrote: ------------------------------------------------------- > 1st year CF = [300,000 - 200,000 ($2M*10%) - > 60,000 - 35,000] * 0.65 = 3,250 > Add back Depreciation (60,000), and subtract > principal payment (234,919 - 200,000) >

because interest was already treated in adjusting the net income to get to the actual cash flow. principal and interest have different treatements since interest is deductible

why dou subtract 60,000 in the Year 1 CF? is that 60,000 depreciation exp?

60,000 is depreciation. It is subtracted initially to calculate the before tax income (As it is tax deductible). But then it is added back (full 60,000) because depreciation is not included in the CF (assumption is that mantainence costs will keep the building in good shape). So in effect we add 35% of 60,000 = 21,000 (tax advantage of depreciation) to the afetr tax cash flows