An analyst is evaluating a real estate investment project using the discounted cash flow approach. The purchase price is $3 million, which is financed 15 percent by equity and 85 percent by a mortgage loan. It is expected that the property will be sold in five years. The analyst has estimated the following after-tax cash flows during the first four years of the real estate investment project.
Cash Flows
Year 1 $60,000
Year 2 $75,000
Year 3 $91,000
Year 4 $108,000
For the fifth year, that is, the year when the property would be sold by the investor, the after-tax cash flow without the property sale is estimated to be $126,000 and the after-tax cash flow from the property sale is estimated to be $710,000
Compute the NPV of this project. State whether the investor should undertake the project. The investor’s cost of equity for projects with level of risk comparable to this real estate investment project is 18 percent.
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