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    Tutorial 7 - Questions

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    Sweethaa Arumugam
    The document describes an investment property that could be sold today or held for another year. If sold today, the after-tax proceeds would be $750,000. If held for another year, the proceeds are expected to be $945,000 after accounting for $50,000 in cash flow and increases in property value, loan balance, and capital gains tax. The marginal rate of return for holding the property another year is calculated to be 32.67%. Given this attractive return, the document recommends holding the property for another year unless a higher return is available elsewhere at similar risk. Renovating the property could increase its value by $300,000 and cash flow by $10,000,

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    Tutorial 7 - Questions

    Uploaded by

    Sweethaa Arumugam
    90 views3 pages
    The document describes an investment property that could be sold today or held for another year. If sold today, the after-tax proceeds would be $750,000. If held for another year, the proceeds are expected to be $945,000 after accounting for $50,000 in cash flow and increases in property value, loan balance, and capital gains tax. The marginal rate of return for holding the property another year is calculated to be 32.67%. Given this attractive return, the document recommends holding the property for another year unless a higher return is available elsewhere at similar risk. Renovating the property could increase its value by $300,000 and cash flow by $10,000,

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    The document describes an investment property that could be sold today or held for another year. If sold today, the after-tax proceeds would be $750,000. If held for another year, the proceeds are expected to be $945,000 after accounting for $50,000 in cash flow and increases in property value, loan balance, and capital gains tax. The marginal rate of return for holding the property another year is calculated to be 32.67%. Given this attractive return, the document recommends holding the property for another year unless a higher return is available elsewhere at similar risk. Renovating the property could increase its value by $300,000 and cash flow by $10,000,

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    90 views3 pages

    Tutorial 7 - Questions

    Uploaded by

    Sweethaa Arumugam
    The document describes an investment property that could be sold today or held for another year. If sold today, the after-tax proceeds would be $750,000. If held for another year, the proceeds are expected to be $945,000 after accounting for $50,000 in cash flow and increases in property value, loan balance, and capital gains tax. The marginal rate of return for holding the property another year is calculated to be 32.67%. Given this attractive return, the document recommends holding the property for another year unless a higher return is available elsewhere at similar risk. Renovating the property could increase its value by $300,000 and cash flow by $10,000,

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 3

    Tutorial 7

    1. A property could be sold today for $2 million. It has a loan balance of $1


    million and, if sold, the investor would incur a capital gains tax of $250,000.
    The investor has determined that if it were sold today, she would
    earn an IRR of 15 percent on equity for the past five years. If not sold, the
    property is expected to produce after-tax cash flow of $50,000 over the next
    year. At the end of the year, the property value is expected to increase to $2.1
    million, the loan balance will decrease to $900,000, and the amount of capital
    gains tax due is expected to increase to $255,000.

    a. What is the marginal rate of return for keeping the property one
    additional year?

    b. What advice would you give the investor?

    Solution 1

    (a)
    If sold today If sold next year
    Sale price $2,000,000 $2,100,000
    Mortgage balance 1,000,000 900,000
    Capital gain tax 250,000 255,000
    Cash flow $ 750,000 $ 945,000

    Marginal return = (Cash flow if sold next year + NOI over next year - Cash flow if sold
    today) / Cash flow if sold today
    Marginal return = ($945,000 + $50,000 - $ 750,000) / $750,000 = 32.67%.

    (b) This appears to be a very attractive return. The property should be held for another year
    unless the investor feels that a higher return can be earned investing the $750,000 elsewhere
    at the same or lower risk.
    2. Refer to Problem 1. The owner determines that if the property were renovated instead of
    sold, after-tax cash flow over the next year would increase to $60,000 and the property could
    be sold after one year for $2.4 million. Renovation would cost $250,000. The investor would
    not borrow any additional funds to renovate the property.
    a. What is the rate of return that the investor would earn on the additional funds invested
    in renovating the property?
    b. Would you recommend that the property be renovated?

    Solution 2

    After-tax cash flow from operations if renovated $60,000


    After-tax cash flow from operations if not renovated - 50,000
    Incremental cash flow from operations $10,000

    Sale proceeds if renovated $2,400,000


    Sale proceeds if not renovated 2,100,000
    Incremental cash flow from sale $ 300,000

    Renovation costs $250,000

    (a) Return from renovation = ($10,000 + $300,000 - $250,000) / $250,000 = 24%

    (b) This appears to be an attractive return, but it must be weighed against the risk of
    renovation. The investor needs to consider whether the $250,000 can be invested elsewhere
    at a higher return with the same or less risk.

    Exercise
    1. A property could be sold today to provide an after-tax cash flow from sale of
    $800,000. The current after-tax cash flow from operations is $20,000, which is
    expected to grow by 4% per year. If sold next year, the property is expected to
    provide an after-tax cash flow of $824,000. What is the marginal rate of return for
    holding the property for an additional year?

    2. Consider the information in the table below. What is the marginal rate of return for
    keeping the property one additional year?
    If sold
      If sold today   next year
    Sale price $ 2,500,000    $ 2,650,000 
    Mortgage balance   1,000,000      900,000 
    Capital gain tax   112,500      135,000 

    Cash flow $ 1,387,000    $ 1,615,000 


                 
    NOI over next year        $ 50,000 

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