. You are asked to evaluate a potential RE equity investment. This investment wi
ID: 1172840 • Letter: #
Question
. You are asked to evaluate a potential RE equity investment. This investment will be held for 5 years if the price is reasonable. In the first year, the net operating income (NOI) is $200,000 and it will yearly increase by 20% as a constant factor. It is expected that the RE investment can be sold after 5 years for $1,500,000. The U.S. Treasury notes with a 5-year maturity are currently yielding at 4% and you expect a liquidity premium of 2.5% pa. Furthermore you require a risk premium of 3.5% for other risks (e.g. operational risk) Calculate the investment value (IV) of the RE investment!Explanation / Answer
NOI in year1 $200,000 NOI in year2 $240,000 (200000*1.2) NOI in year3 $288,000 (240000*1.2) NOI in year4 $345,600 (288000*1.2) NOI in year5 $414,720 (345600*1.2) Discount Rate=Risk free rate+Liquidity Premium+Risk Premium Discount Rate=4%+2.5%+3.5%= 10% Present Value (PV) of Cash flow=(Cash flow)/(1+i)^N i=Discount rate=10%=0.1 N=Year of Cash flow N A B=A/(1.1^N) Year Cash Flow PV of Cash flow 1 $200,000 $ 181,818 2 $240,000 $ 198,347 3 $288,000 $ 216,379 4 $345,600 $ 236,049 5 $414,720 $ 257,508 SUM $ 1,090,102 Investment Value(IV) of the RE investment $ 1,090,102
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