ATIRR Unlevered: Income taxes are taken into account in the calculation of IRR.

Question

ATIRR Unlevered: Income taxes are taken into account in the calculation of IRR.

This is a continuation Part I. The additional information is:

* 75% of Mr. Beyer’s purchase price of $92,000,000 is attributable to the improvements (the building) and will be depreciated on a 39-year straight-line basis. As you know, depreciation is a deduction for purposes of calculating taxable income. (The 25% portion of the price attributable to land is, of course, not depreciable.)

* The front-end closing costs of $600,000 are capitalized and amortized evenly over his anticipated five-year holding period. Closing costs are a deductable item.

* The income tax (the tax on each year’s taxable income from operations) rate is 36%.

* Gains Tax: His capital gain (the net sales proceeds in excess of his depreciated basis) is segmented into (a) the net sales proceeds in excess of his purchase price, which is taxed at a rate of 15%, and (b) the amount of depreciation he has taken during his ownership, which is taxed at a rate of 20%.

The $3,500,000 capital expenditure in the fifth year will not be depreciated by Mr. Beyer since it is made during the same period as his disposition of the property.

What is Mr. Beyer’s after-tax IRR (ATIRR)?

SHOW IN EXCEL

Explanation / Answer

BTIRR calculations Year 0 Year 1 2 3 4 5 6 Initial purchase price -92000000 Operating Income Year 2=(Year 1*1.04) & so on 8460750 8799180 9151147 9517193 9897881 10293796 Closing costs(-600000/5) -120000 -120000 -120000 -120000 -120000 10300000 Sale projected less cost of brokerage(See schedule) 110316940 Upgrading costs(given) -3500000 Net cash flows -92000000 8340750 8679180 9031147 9397193 116594821 IRR as per EXCEL function 12% Schedule for net sale proceeds Operating income projeted for Year 6(9897881*1.04) 10293796 Rounded off to nearest lakh 10300000 Projected Sale price (Capitalised @9.15% ie.10300000/0.0915 112568306 Less: Brokerage @ 2% 2251366 Net sale proceeds 110316940 ATIRR Calculations Net cash flows as per BTIRR -92000000 8340750 8679180 9031147 9397193 116594821 Less:depn on buildings92000000*75%/39 yrs. 1769231 1769231 1769231 1769231 1769231 Taxable Income -92000000 6571519 6909949 7261916 7627962 114825590 Less:Tax @ 36% of taxable Income 2365747 2487582 2614290 2746066 41337212 Less: 15% tax on18316940(110316940-92000000) 2747541 Less:20% tax on 8846154(1769231*5) Excel rounding off error(1) 1769231 Cash flow after tax -92000000 4205772 4422368 4647627 4881896 68971606 Add back tax savings due to depn.36% for yrs.(1-4)& 36+20=56% for (yr.5) 636923 636923 636923 636923 990769 Net annual cash flow projected(ATIRR) -92000000 4842695 5059291 5284550 5518819 69962375 (AT)IRR as per EXCEL function -0.3277% Note: Closing costs deduction already done in BTIRR calculations

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