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FINA 320 > Powerpoint class 6 > Flashcards

Powerpoint class 6 Flashcards

1
Q

Why Investment Value Differs from Market Value

A

Investors have different required returns

–> Different risk assessment/opportunity cost of invested equity

Investors have different expectations about future:

–> rental rates

–> vacancies

–> operating expenses

–> etc.

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2
Q

Operating expenses

A

Keep property operating & competitive

Do not increase value or extend useful life

Examples: minor roof repairs, air conditioner servicing, lawn maintenance, utilities, etc.

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3
Q

Capital Expenditures

A

Increases market value of property/extend life

Examples: roof replacement, air-conditioner replacement, installation of new landscaping

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4
Q

Why do investors borrow?

A

Limited financial resources/wealth

Leverage amplifies equity returns (& risk)

Also permits more portfolio diversification

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5
Q

Cash flow effect of borrowing

A

Net operating income

− Debt service

= Before-tax cash flow (BTCF)

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6
Q

Questions to ask ourselves regarding cash flow estimates

A

Are income & expenses items appropriate?

Have trends for each item been carefully considered?

What about comparable properties?

What are the social & legal environments?

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7
Q

which are the only income and expenses that we should include?

A

Include only income & expenses that relate directly to income producing ability of property

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8
Q

what should we consider regarding trends?

A

Should not just extrapolate recent trends

Importance of rental rate growth & vacancy assumptions

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9
Q

what should we do with comparable properties?

A

Should obtain as much information as possible on comparable/substitute properties

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10
Q

what should we know about social & legal environments?

A

Zoning, land use, & environmental controls change quickly at state & local levels

How has subject’s neighborhood been changing?

Are local public officials pro or anti-growth?

Trends in property taxes?

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11
Q

How are all CFs & income tax consequences considered when using partnerships & limited liability companies?

A

all CFs & income tax consequences are allocated and “flow through” to individual investors

further analysis is usually required to determine expected CFs & returns earned by various equity investors

–>

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12
Q

Profitability ratios we need

A

Capitalization rate (Ro)

Equity dividend rate

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13
Q

Multipliers we need

A

Net income multiplier

Effective gross income multiplier (EGIM)

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14
Q

Financial risk ratios we need

A

Operating expense ratio

Loan-to-value ratio (LTV)

Debt coverage ratio (DCR)

Debt yield ratio (DYR)

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15
Q

Capitalization rate formula

A

NOI / Acquisition price

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16
Q

Equity Dividend rate formula

A

BTCF / Equity Investment

17
Q

Net Income Multiplier formula

A

Acquisition price / NOI

18
Q

Effective gross income multiplier formula

A

Acquisition price / Effective gross Income (EGI)

19
Q

Operating expense ration formula

A

OE / EGI

20
Q

Loan-to-value ratio formula

A

Mortgage amount / property value

21
Q

debt coverage ratio formula

A

NOI / Debt service

this should ideally be over 1

22
Q

Debt yield ratio formula

A

NOI / Loan amount

23
Q

Pros of Ratios & Multipliers

A

Quick & relatively easy to compute

Intuitive

Facilitates comparison with similar properties

No explicit assumptions about future

24
Q

Cons of Ratios & Multipliers

A

No clear benchmarks for acceptable range

Only a partial view of performance

No explicit assumptions about future

25
Q

what must investors do when using multi-year discounted CF decision making methods?

A
  1. Estimate how long she expects to hold property
  2. Make explicit forecasts of:

–> property’s net CF for each year,

–> net CF produced by expected sale of property

  1. Select rate of return at which to discount all future CFs
26
Q

BTCFs

A

“levered” cash flows

27
Q

who has first claim on the property’s cash flows

A

Lender(s)

28
Q

Owner’s claim on a property’s CFs refereed to as what?

A

as a “residual claim”

29
Q

Levered Cash Flow

A

measure property’s income after subtracting mortgage payments

30
Q

Valuation of levered CFs?

A

Discount expected levered BTCFs rather than yearly NOIs

31
Q

which is more risky between levered cashflows and unlevered cashflows?

A

levered cashflows

32
Q

Net Present Value (NPV)

A

NPV = PV(Cash Inflows) – PV (Cash Outflows)

33
Q

Discount Rate at which NPV = 0

A

IRR

34
Q

Effect of Leverage on NPV and IRR

A

Increased leverage usually increases both NPV & IRR—holding mortgage rate & all other assumptions constant

But…leverage also increases risk to equity investor, thus required equity return should increase with leverage

35
Q

Cash flows & returns most important to investors are?

A

after-tax cash flows & returns

36
Q

After-tax required return

A

before-tax return x (1−TR)

FINA 320 (10 decks)

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