Real Estate - After-Tax Cash Flow Question

Biggs, Inc. is considering a real estate investment that provides gross revenues (if fully occupied) of $250,000, a vacancy rate of 4%, and operating expenses of $15,000. The property costs $1,000,000, and the depreciation expense on the property is 2.6% of the cost in the first year and 1.3% of the cost over the next several years. The marginal tax rate is 35%. The after-tax cash flow in year one from the potential investment is: A. $69,650 B. $129,350 C. $146,250 D. $155,350

It’s been a looong time since I touched AI… used the income approach to value this piece of Real Estate Lemme know if C is correct? [250K (revenue) - 10K(vacancy losses) - 15K( Operating Expenses)]*(1 - 0.35) = 146.25K - Dinesh S

D (250k-10k-15k-26k (depreciation) ) * .65 = 129.350 add back 26k dep = 155350 Dinesh, you have to deduct depreciation because that is tax deductible, and you add it back afterwards because it is not an actual cash expense.

Nope. Schweser says D, which brings pretax income to $239,000 . Not sure why…

Perfect!!! Thank you. Should have realized this, it’s exactly what we are doing in FSA to determine CF…adding back depreciation after NI.

thanks LongOnCFA, then which is the RE-valuation method that does not consider depreciation? Is it NOI ? I know for sure, the only other technique left i.e. the Hedonic Approach needs the key parameters (weighted-coefficients)? I think I need to hit the AI module all over again… - Dinesh S

Dinesh, Yup, NOI does not take into account depreciation or personal income tax (property taxes still need to be deducted).

thanks LongOnCFA, Just to nail it down completely… NOI does not take into account all these things… 1. Depreciation 2. Financing Costs & 3. Personal Taxes (Property Taxed considered) - Dinesh S

Dinesh, that’s correct.