An investor has three possible scenarios for a project as follows:
Pessimistic – NOI will be $220,000 for the first year, and then decrease by 3 percent per year over a five-year holding period. The property will sell for $1.7 million after five years.
Most likely – NOI will be level at $220,000 per year for the next five years and the property will sell for $2.5 million
Optimistic – NOI will be $220,000 the first year and increase 3 percent per year over a five-year holding period. The property will sell for $2.8 million.
The asking price of the property is $2.2 million. The investor believes that there is a 30% probability of the pessimistic scenario, a 50% probability for the most likely scenario, and a 20% probability for the optimistic scenario.
If a loan of $1.2 million is used to purchase the property at a 8 percent interest rate with a 15 year term, calculate the expected IRR and the standard deviation of the return on equity (ignore taxes). Contract your findings with those obtained in (a) and (b) above.