A group of investors is interested in purchasing an office building. They will need an initial investment of $2,000,000. The office building is currently leased to tenants, and the investors have reviewed the office building leases to determine rent and past accounting statements to determine operating expenses. The net rent for the first year is $262,500. Based on the lease rent provisions and estimates of future operating expenses, the investors project that the net rent will increase by 5% a year. Also, based on a study of market conditions, the investors estimate that they will be able to sell the building in four years and net $2,928,200.00. The investors require an 18% return.
1. What are the NPV and IRR of this real estate investment? Show how you arrived at your answers.
2. Is this a good investment for the investors? Why or why not?
3. Theoretically, what could happen if the investors are wrong about their projections of future cash flows?