PART 1 Unlevered BTIRR problem The property is a specialty retail property (whic
ID: 2715730 • Letter: P
Question
PART 1
Unlevered BTIRR problem
The property is a specialty retail property (which is interesting, but not relevant to the solution). Mr. Beyer is planning to acquire the property, hold it for five years and then sell it at the end of the fifth year.
* The first year net operating income (NOI) is projected to be $8,460,750. Mr. Beyer is projecting that, based on increasing base rents and increasing percentage rents, his NOI will increase at a compounded annual rate of 4%.
* His closing costs (legal, recording, appraisal, environmental, engineering, title, etc.) will come to $600,000. These closing costs will be expended simultaneous to taking title.
* In the fifth year of the holding period, in order to prepare the property for disposition, Mr. Beyer intends to spend $3,500,000 in property upgrade, and he builds in that assumption to his numbers. This capital expenditure is, of course, an increase in his equity investment.
* Mr. Beyer projects his sale to the next purchaser at the end of the fifth year. The sales price will be determined by utilizing a residual or terminal capitalization rate of 9.15% of the projected sixth year NOI (rounded to the nearest $100,000). After all, the next buyer is buying future income, not past income. But Mr. Beyer also projects a cost of sale (legal, marketing, brokerage) of an amount equal to 2% of the gross sales price. This cost of sale will be deducted from his gross sale price to arrive at net sales proceeds.
If all of Mr. Beyer’s projections are accurate, and if he pays $92,000,000 for this property, what will be his before tax IRR (BTIRR)?
ANSWER FOR PART 1
PART 2
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
Gross Sales Price Net Sales Price (not rounded) (92,000,000) 5 (600,000) Purchase Price Closing costs NOI CapEx Net sales proceeds Cash flow 8,460,750 s 8,799,180 S 9,151,147 5 9,517,193 5 9,897,881 (3,500,000) 110,250,000 $ (92,600,000) $ 8,460,750 8,799,180 9151,147 9517,193 116,647,881 10,293,796 112500,503 S 110,250,493 5 9326003 -67595 293.40 5 353 457 5 3517,48 RR calculation 12. 2096Explanation / Answer
Calculation of Before Tax IRR 0 1 2 3 4 5 Purchase price -92000000 Closing costs -600000 Net Operating Income 8460750 8799180 9151147 9517193 9897881 Cost of Upgrade -3500000 Net Sale Proceeds 110250000 Total Cash Flows -92600000 8460750 8799180 9151147 9517193 116647881 Internal Rate of return 12.20% Calculation of After Tax IRR 0 1 2 3 4 5 Purchase price -92000000 Operating Flow 6095003 6311598 6536857 6771127 7014767 Cost of Upgrade 3500000 Net Sale Proceeds 107595192 Total Cash Flows -92000000 6095003 6311598 6536857 6771127 118109959 Internal Rate of Return = 10.44% Purchase Price 92000000 Percentage attributable for Depreciation 75% of Purchase Price Depreciation rate straight line 39 years Depreciation amount = (92000000*0.75)/39 1769231 Net operating Income in yr I 8460750 annual growth rate 4% Closing Costs 600000 Amount amortized for 5 years = 600000/5 120000 Cost of Property Upgrade 3500000 terminal capitalization rate 9.15% Income Tax rate 36.00% Sale value at end of fifth year at terminal capitalization rate of projected 6th year NOI rounded to $100000 Cost of sale 2% of gross sales price 1 2 3 4 5 6 Net Operating Income 8460750 8799180 9151147 9517193 9897881 10293796 Depreciation 1769231 1769230.8 1769231 1769231 1769231 Amortization of closing cost 120000 120000 120000 120000 120000 EBIT 6571519 6909949 7261916 7627962 8008650 Tax at 36% 2365746.9 2487581.7 2614290 2746066 2883114 Net Income 4205772 4422368 4647627 4881896 5125536 Operating Flow 6095003 6311598 6536857 6771127 7014767 Net Income + Depreciatiion + Amortization 6th Year NOI 10293796 Capitalization rate 9.15% Gross sales Price 112500503 cost of sale 2250010 Net Sale Price 110250493 110250000 (rounded off to nearest $100000) Net Sale Price 110250000 Depreication for 5 years 8846154 = 1769231*5 Net Value 101403846 Less Cost of Property 92000000 Less cost of upgrade 3500000 Net Capital gains (net of depn) 5903846 Tax on total depn for 5 years 20% 1769231 =8846154*0.2 Tax on capital gain net of depn 15% 885577 =5903846*0.15 Total Tax Payable 2654808 Amount received net of taxes 107595192 = Net sale value - taxes
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