Evaluate the purchase of an existing 850 unit apartment complex for $4200000, the building is assumed to have a 20 year functional life. Treat the rents as being collected at the end of each year, along with associated variable and fixed costs. Assume rent controls will prohibit the rent from being raised over the life of the building. Assume that the underlying property reverts to the original owners at the end of twenty years, and that you will also be responsible for demolition and clean-up costs, to be incurred at the end of the building’s life.
- Rentals are estimated at 765 units per year
- Each unit will be rented for a cumulative monthly amount of $6100 per year
- Cost per unit when rented $4300 per year
- Fixed costs $250000 per year for the building, other than the initial investment
- Demolition/Clean up $3400000 after-tax
- Depreciation is to be straight-line
- Assume the project can be financed at 12% (before-tax) using debt
- Tax Rate is 40%
A) Given the structure of the cash-flows, can this investment have more than one IRR, if so how many and why?
A Yes, 3, because there are three changes in sign. B Yes, 2, because there are two changes in sign of the CF’s. C No, because the sum of the cash-flows are positive. D Yes, 2, because the PV of the middle cash-flows could be less than the PV of the negative cash-flows. E Yes, 3, because the sign changes follow the order: minus plus minus
B) Assume the same $4200000 initial investment, $900000 after-tax OCF and $3400000 after-tax exit cost. Suppose your company uses the payback rule to evaluate investments. If the allowed payback period is 7 years, what decision does the rule indicate? A Invest B Reject
C) Suppose the allowed payback period is 6 years, what decision does the rule indicate? A Invest B Reject
D) Suppose your company evaluates projects on a 7-year payback period. What is your decision if you use the discounted payback rule, what would your decision be? (before-tax discount rate is 14%) A Reject B Invest
E) Suppose your company evaluates projects on a 6-year payback period. What is your decision if you use the discounted payback rule, what would your decision be? (before-tax discount rate is 14%) A Invest B Reject