You are considering the acquisition of a small office building. The purchase price is $775,000. Seventy-five percent of the purchase price can be borrowed with a 30-year, 7.5 percent mortgage. Payments will be made annually. Up-front financing costs will total three percent of the loan amount. The expected before-tax cash flows from operations–assuming a 5-year holding period—are as follows:
| Year | BTCF |
| 1 | $48,492 |
| 2 | 53,768 |
| 3 | 59,282 |
| 4 | 65,043 |
| 5 | $71,058 |
The before-tax cash flow from the sale of the property is expected to be $295,050. What is the net present value of this investment, assuming a 12 percent required rate of return on levered cash flows? What is the levered internal rate of return?
Solution: As solved below, the NPV is ($11,166) and the IRR is 10.75 percent
|
Year |
Equity Investment |
NOI |
Debt Service |
BTER |
Total Cash Flow | Present Value
at 12% |
| 0 | ($211,188) | ($211,188) | ($211,188) | |||
| 1 | $48,492 | $49,215 | (723) | (646) | ||
| 2 | 53,768 | 49,215 | 4,553 | 3,630 | ||
| 3 | 59,282 | 49,215 | 10,067 | 7,165 | ||
| 4 | 65,043 | 49,215 | 15,828 | 10,059 | ||
| 5 | $71,058 | $49,215 | $295,050 | $316,893 | $179,814 |
