Investment Techniques Flashcards
What does a DCF stand for?
Discounted Cash Flow
What is a DCF?
Valuation method used to estimate the value of an investment based on its future cash flows
A DCF is growth _______
Explicit
What does DCF show?
The profitability, or even the mere viability in comparison to desired rate of return.
Estimates value of an asset today, based on projections of how much money it will generate in the future.
Future earning discounted to PV by desired rate of return
What is the estimated value today from a DCF?
Net Present Value NPV
What factors need to be factored in to the calculation?
Initial cost—Either the purchase price or down payment made on the property.
Financing costs—The interest rate costs on any initial or expected financing.
Rental Growth - Increase or decrease of rental market rent
Void periods - Period for re-letting
Holding period—For real estate investments, the holding period is generally calculated for a period of between five and 15 years, although it varies between investors and specific investments.
Additional year-by-year costs—These include projected maintenance and repair costs; property taxes; and any other costs besides financing costs.
Projected cash flows—A year-by-year projection of any rental income received from owning the property.
Sale profit—The projected amount of profit the owner expects to realize upon sale of the property at the end of the projected holding period.
Benefits of using a DCF?
- Extremely detailed
- Includes all major assumptions about the business
- Growth explicit
- Produces a NPV & IRR
Limitations of DCF?
- Requires a large number of assumptions
- Prone to errors
- Prone to overcomplexity
Why did you use a traditional investment method?
Simplicity and comparability
When is a rate of return calculated?
Retrospectively
Simple methodology to find the market value:
- Estimate the cash flow (income less expenditure)
- Estimate the exit value at the end of the holding period
- Select the discount rate )
- Discount cash flow at discount rate
- Value is the sum of the completed discounted cash flow to provide the NPV
What is the main reason for using a DCF?
The approach separates out and explicitly identifies growth assumptions rather than incorporating them within an ARY
Examples where a DCF may be suitable?
- Short leasehold interests and properties with income voids or complex tenures
- Phased development projects
- Some ‘Alternative’ investments
- Non-standard investments (say with 21-year rent reviews)
What does IRR stand for?
Internal Rate of Return
What is a IRR?
The rate of return at which all future cash flows must be discounted at to produce a NPV of zero.
