Problem
When raising the additional capital to invest in the property, you need to raise an additional $1,000,000 from an investor to add to your $500,000 in investment and the bank loan in order to finance the cost of the property. In negotiations with the partner, you promise them a 15% non-cumulative preferred payment on her investment each year, after which you receive a 20% non-cumulative payment on your investment. The extra percentage you receive is in compensation for managing the property. For any cash flow remaining after the preferred payments, it will be split 50-50 between the partners.
At the end of the project, your investor is promised a return preference of 25%, and after receiving that payment, all additional cash flow from the sale of the asset will go to you.
i. How much of the year two free cash flow will go to the investor? ($167,856)
ii. How much will you receive from the third year's cash flow? ($122,351)
iii. How much will have to be paid to the investor from the terminal cash flow in order to give them a 25% return on their investment? ($1,652,946)
iv. What is the return you have earned on your $500,000 invested capital? (33.9%)
v. Using the free cash flows to the project, what would be the market value of the firm's equity if you believe the required cost of equity was 15%? ($2,290,649)