Chapter 11-Homework ProblemsProblem 11-2

You are an officer with University Realty Consultants and have been given the following consulting assignment:You are to produce an investment analysis of a new small commercial (REV) income-producing (rental) property for purchase by an investor. Key variables which you’ve determined via your due diligence are as follows:

Asking (Purchase) Price is $1,250,000 Potential rents are estimated at $200,000 for year one and are expected to grow by 3% each year thereafter There is no Miscellaneous Income Vacancy / collection losses are estimated at 10% Operating Expenses (OPEX) are estimated at 35% of EGI You’ve chosen to ignore CAPX or CAPX reserves Loan assumptions … 70% LTV (of Purchase Price) at 11% interest for 30 years Property value appreciation at 3% per year throughout hold period Hold period assumed to be 5 years and there are no selling costs Investor has a risk adjusted after-tax “required yield / discount rate / opportunity cost” for this potential

investment of 14%

Based upon the above assumptions;

a) What is the investor’s BTIRRe ?b) What is the lender’s 1st year DCR ?c) What is the terminal (“going-out”) cap rate ?d) What is the potential investor’s initial equity dividend rate ? e) Can we conclude from the cash-on-cash yield whether the investor might achieve his required yield ?f) The terminal cap rate and the going in cap rate are usually quite different. Is the interesting relationship you see

here in this problem coincidental ? Why or why not ?

As you have done on other homework, ATTACH YOUR COPY OF THE TEMPLATE (#1) WHICH SHOWS YOUR WORK, AND HIGHLIGHT OR CIRCLE YOUR ANSWERS ON THE TEMPLATE (ONE PAGE).

TEMPLATE INSTRUCTIONS: Use either … your Revised Cartwright Template … or … the Chapter 11 ATIRR template from the Course Templates (Blackboard) to answer the questions. Suggestion: before deciding which template to use, first review the

ANS: 15.04%

ANS: 1.17

ANS: 9.36%

ANS: 4.53%

Y/N : Yes

Y/N : No

WHY / WHY NOT: No, I believe this relationship implies that the property may be overpriced or require t0o high of an initial investment relative to the selling price.

Student Name: Aaron Bomar* Graded By : ___________________________

Stapled ? (Y/N) _____All Work on Form ? (Y/N) _____Attached Spreadsheet ? (Y/N) _____No. Correct (of 16): _____

* By putting my “Student Name” to the above I hereby certify that all work, and all copies, are mine alone

remainder of the homework problems. Note, should you choose to use the Course Template, it is structured to provide the answers to these particular problems, BUT… you are going to have to incorporate another spreadsheet to generate the Net Operating Incomes for the years under consideration (attach or incorporate this separate spreadsheet if you choose to go this route). DO NOT try to use the other Chapter 11 course templates to do this (generate the NOI). While it is feasible to do so, it is unduly complicated and will likely take you 3-5 times longer. Should you choose to use the Cartwright Template, almost everything that you need is there … PLUS SOME. Therefore you will need to already be quite familiar with the Cartwright Template, its nuances, and how to adjust it for these particular problems as well as those below. In other words, neither of these templates are pure “plug and play. The templates … and this form … can be copied in grayscale in lieu of color. This will be the case for all future template assignments as well (except Cartwright).

Problem 9-3

After you’ve completed the before-tax analysis (per the above), you now want to consider the effects of federal income taxation upon the potential investment. Here are some of the key variables that you wish to incorporate in your analysis;

The building represent 90% of the Purchase The property is considered by the IRS to be Commercial versus Residential The potential investor is in a 30% Effective and a 36% Marginal tax bracket The investor has other passive investments and can apply passive losses from this investment (if any) against

(positive) passive income from those other sources. Therefore he / she would not be subject to PAL limitation rules.

The investor’s Long Term Capital Gains Rate is 20% Recapture is at the current (2014) statutory rate

Again, use this same Revised Cartwright Template … (#1) or the Chapter 11 ATIRR template … (#1) that you used in Problem 9-2 above and continue it with these taxation assumptions to answer the questions listed below

a) What is the investor’s ATIRRe ?b) What is the Effective Tax Rate ?c) Note the effect of taxes and the reduction in yield from the BTIRR to the ATIRR. Would you categorize the overall

“tax benefits” to be … “nil” … “minor” … or “significant”. d) Which template measure, or comparison between two measures, best quantifies this categorization you

expressed in c.) above ?e) What is the after-tax NPV ?f) Can we conclude from the NPV whether or not the investor is likely to achieve his “required yield” ?g) Will he ?h) (New template #2). If you changed both the Capital Gains and the Recapture tax rates to 5%, what is your

revised ATIRR ?i) (New Template #3). Restore the Capital Gains and Recapture tax rates to the original assumptions (ignore the

changes in question h). above) … Now, assume that the potential investor CANNOT deduct any of the passive losses generated in the operating years, but must instead suspend them until the property is sold at the end of the hold period. What is the revised ATIRR ?

ANS: 11.89%

ANS: 20.96%

ANS: significant

ANS: _The difference in ordinary income tax rate and effective tax rate

ANS: -$15,986

Y/N : yes

Y/N : No

ANS: 14.50%

ANS: 11.89%

ATTACH YOUR COPY OF THE TEMPLATES WHICH SHOW YOUR WORK, AND HIGHLIGHT OR CIRCLE YOUR ANSWERS ON THE TEMPLATE (ONE PAGE).

Rev. 3/19/15