Use the same information as in problem. Now assume a loan for $1.5 million is obtained at a 10 percent interest rate and a 15-year term.
a. Calculate the expected IRR on equity and the standard deviation of the return on equity.
b. Contrast the results from (a) with those from problem 3. Has the loan increased the risk? Explain.
Problem:-
An investor has projected three possible scenarios for a project as follows: Pessimistic-NOI will be $200,000 the first year, and then decrease 2 percent per year over a five-year holding period. The property will sell for $1.8 million after five years. Most likely-NOI will be level at $200,000 per year for the next five years (level NOI) and the property will sell for $2 million. Optimistic-NOI will be $200,000 the first year and increase 3 percent per year over a five-year holding period. The property will then sell for $2.2 million. The asking price for the property is $2 million. The investor thinks there is about a 30 percent probability for the pessimistic scenario, a 40 percent probability for the most likely scenario, and a 30 percent probability for the optimistic scenario.
a. Compute the IRR for each scenario.
b. Compute the expected IRR.
c. Compute the variance and standard deviation of the IRRs.
d. Would this project be better than one with a 12 percent expected return and a standard deviation of 4 percent?