Suppose you have developed the following information for a potential investment:

Question

Suppose you have developed the following information for a potential investment: Current market value is $1,200,000; anticipated loan to value ratio I s .80 with 2 points; and predicated cash flows of
ATCF1 = $38,560 ATCF2 = $41,780 ATCF3 = $37,210 ATCF4 = $39,127 ATER4 = $191,730 Further, assume the investor's minimum required after-tax rate of return on equity is 12%.

Please solve showing all steps: a. What is the internal rate of return on this potential investment? b. What is the profitability index on this investment? Suppose you have developed the following information for a potential investment: Current market value is $1,200,000; anticipated loan to value ratio I s .80 with 2 points; and predicated cash flows of
ATCF1 = $38,560 ATCF2 = $41,780 ATCF3 = $37,210 ATCF4 = $39,127 ATER4 = $191,730 Further, assume the investor's minimum required after-tax rate of return on equity is 12%.

Please solve showing all steps: a. What is the internal rate of return on this potential investment? b. What is the profitability index on this investment? Suppose you have developed the following information for a potential investment: Current market value is $1,200,000; anticipated loan to value ratio I s .80 with 2 points; and predicated cash flows of
ATCF1 = $38,560 ATCF2 = $41,780 ATCF3 = $37,210 ATCF4 = $39,127 ATER4 = $191,730 Further, assume the investor's minimum required after-tax rate of return on equity is 12%.

Please solve showing all steps: a. What is the internal rate of return on this potential investment? b. What is the profitability index on this investment? Suppose you have developed the following information for a potential investment: Current market value is $1,200,000; anticipated loan to value ratio I s .80 with 2 points; and predicated cash flows of
ATCF1 = $38,560 ATCF2 = $41,780 ATCF3 = $37,210 ATCF4 = $39,127 ATER4 = $191,730 Further, assume the investor's minimum required after-tax rate of return on equity is 12%.

Please solve showing all steps: a. What is the internal rate of return on this potential investment? b. What is the profitability index on this investment?

Explanation / Answer

Solution:

Market value of the investment = $1,200,000

Loan to Value ratio = 0.80 which means that 80% can be borrowed (debt) while owners' (equity) investment is 20%

Therefore, Initial Investment = 20% of 1,200,000 = $240,000

a) IRR:

IRR is simply the rate of return which will make the Initial Investment equal to the sum of P.V of after tax cash flows.

Numerically, it should be the rate of return such that the sum of discounted values of following euals $240,000:

38,560

41,780

37,210

39,127

191,730

Using Excel or Financial Calculator, IRR = 10.41%

(For excel, use the IRR formula; IRR = (-Initial Investment, ATCF1, ATCF2, ATCF3, ATCF4, ATCF5)

b) Profitability Index: First find out the present value of each-year's after tax cash flows

38,560

41,780

37,210

39,127

191,730

Profitability Index is defined as the Sum of Present Value (PV) of Cash Flows/ Initial Investment

Here,

Sum of P.V Cash Flows = $ 227,879.34

Initial Investment = $ 240,000

Therefore, PI = 227879.34/ 240000 = 0.95

Note: As you can observe, both measures will lead to non-acceptance of this investment:

IRR: Since IRR of 10.41% is lower than the MARR of 12%, this invetsment should be rejected

Profitability Index (PI): Since PI's value is less than 1.00, the investment should be rejected

Years 1 2 3 4 5 After-Tax Cash Flows

38,560

41,780

37,210

39,127

191,730

Discounting Formula 38560/(1+IRR)^1 41780/(1+IRR)^2 37210/(1+IRR)^3 39127/(1+IRR)^4 191730/(1+IRR)^5

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