REAL ESTATE - INITIAL OUTLAY

CFA Level II
#1

SCHWESER - VOL1, PAGE150, Q36 in the IRR computing, the answer said the initial outlay is “the initial equity investment”, which does not contain the portion of financed(80% of the purchase price), only 20% of the purchase price is calculated as CF0 is it correct to only include the cash portion? and is it also applicable to the Corporate finance assigned reading - can it be used to value the project planning? Hope someone could clarify…thanks.

#2

I am not sure about the corporate finance issue, but for real estate you only include the “cash” portion, not the debt portion. I have never come across a corporate finance question where the initial outlay was given as partially debt partially equity. But I guess, theoretically, the same principal should apply.

#3

I’m pretty sure for corporate finance you would use the entire purchase price, regardless of what was paid for with debt. Usually the financing criteria are shown in the WACC that is used, rather than adjusting the cash flows.

#4

thanks both… call for more help… why only in real estate part we need to consider equity investment portion solely?..

#5

somebody pls help…-_-

#6

I think for real estate investment the initial outlay considers only the equity investment is b/c the debt portion is paid off when you are computing the final after-tax cf (the after-tax equity reversion) since the equity reversion includes your selling price - selling cost - amortized mortgage balance - tax. Also,when you are calculating the ATCF you are subtracting the annual debt service. This and the mortgage payback in the equity reversion will be already included in your calculation of the NPV and therefore you don’t include it in your initial outlay. If you were to do so, you’d be double counting it.

#7

Adding to the above, the equity portion is included in the initial outlay b/c its the money you fork out at the beginning whereas for the debt portion you are borrowing it from say… a bank. So it is the bank that is forking out the money initially not you, hence, debt portion not included in the initial outlay. However, debt has to be repaid back and that is included in the equity reversion.