evercd are considering the purchase of an apartment complex. The following assum
ID: 2794735 • Letter: E
Question
evercd are considering the purchase of an apartment complex. The following assumptions are made: . The purchase price is SI million. , Potential gross income (PGI) for the first tions is projected to be $171,000. , PGl is expected to increase 4 percent per year. , No vacancies are expected. , Operating expenses are estimated at 35 percent of effec- tive gross income. Ignore capital expenditures. , The market value of the investment is expected to increase 4 percent per year. . Selling expenses will be 4 percent. . The holding period is four years. The appropriate unlevered rate of return to discount pro- jected NOls and the projected NSP is 12 percent.Explanation / Answer
g.
Solution:
Principal reduction in year 1 = $700,000 - $694,152 = $5,848
Principal reduction in year 2 = $694,152 - $687,820 = $6,332
Principal reduction in year 3 = $687,820 - $680,961 = $6,859
Principal reduction in year 4 = $680,961 - $673,533 = $7,428
h.
Solution:
Interest paid in year 1 = $61,636 - $5,848 = $55,788
Interest paid in year 2 = $61,636 - $6,332 = $55,304
Interest paid in year 3 = $61,636 - $6,859 = $54,777
Interest paid in year 4 = $61,636 - $7,428 = $54,208
i.
Solution:
Loan amount (0.70 x $1,000,000) = $700,000
Up-front financing costs (0.02 x $700,000) = $14,000
Equity investment = $1,000,000 - $700,000 + $14,000 = $314,000
j.
Solution:
Item
1
2
3
4
NOI
$111,150
$115,596
$120,220
$125,029
less: Debt Service
61,636
61,636
61,636
61,636
BTCF
$49,514
$53,960
$58,584
$63,393
k.
Solution:
Item
Amount
Net selling price
$1,123,065
less: Remaining mortgage balance in year 4
673,533
Before-tax equity reversion
$449,532
l.
Solution:
Item
Cash Flow
Present Value at 14%
BTCF Yr.1
$49,514
$43,433
BTCF Yr.2
53,960
41,520
BTCF Yr.3
58,584
39,543
BTCF Yr.4
63,392
37,534
Reversion Yr. 4
449,532
266,159
Total
$428,189
NPV = Present value of the cash flows less the equity investment:
$428,189 - $314,000 = $114,189.
Decision: Purchase the property because the NPV > 0; wealth will increase by $114,189.
m.
Solution: Levered IRR = 25.02 percent; Decision: Purchase the property because IRR > 14 percent, the required return.
n.
(1)Overall cap rate = NOI / Market price = $111,150 / $1,000,000 = 11.12%
(2)Equity dividend rate = BTCF / equity = $49,514 / $314,000 = 15.8 percent
(3)Gross income multiplier = Market price / EGI = $1,000,000 / $171,000 = 5.85
(4)Debt coverage ratio = NOI / Debt service = $111,150 / $61,636 = 1.8
Item
1
2
3
4
NOI
$111,150
$115,596
$120,220
$125,029
less: Debt Service
61,636
61,636
61,636
61,636
BTCF
$49,514
$53,960
$58,584
$63,393
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