PROP 1020 / CHAPTER 8 Flashcards
NOTE ONLY / RETURN MEASURES
Investment analysis typically focuses on return on equity, considering that most real property is at least partially financed. The investor’s primary concern is the return on their equity investment, not the return on the overall property value.
The return on this equity investment is a combination of the after-tax cash flows (ATCF) received from the property’s operations over the investment’s holding period plus the proceeds of sale, or the after-tax equity residual (ATER).
NOTE ONLY / RETURN MEASURES
Investment analysis typically focuses on return on equity, considering that most real property is at least partially financed. The investor’s primary concern is the return on their equity investment, not the return on the overall property value.
The return on this equity investment is a combination of the after-tax cash flows (ATCF) received from the property’s operations over the investment’s holding period plus the proceeds of sale, or the after-tax equity residual (ATER).
List 4 single period return measures.
Return on investment
Equity dividend rate
Cash on cash return
Holding Period Return
What is the formula for ROI?
ROI = NOI ÷ PURCHASE PRICE
The _____ is in essence the free and clear rate of return, the investor’s return on a before-financing, before-tax basis.
The ROI is in essence the free and clear rate of return, the investor’s return on a before-financing, before-tax basis.
Another measure often utilized in real estate investment analysis is the equity dividend rate (EDR). The EDR is the ratio of the property’s _______ cash flow to the investor’s ________
Another measure often utilized in real estate investment analysis is the equity dividend rate (EDR). The EDR is the ratio of the property’s before-tax cash flow (BTCF) to the investor’s initial equity investment.
What is the formula for Equity Dividend Rate?
EDR = BTCF ÷ EQUITY INVESTMENT
With the tax shelter benefits available in real estate investment, some investors prefer an equity return measure derived on an after-tax basis. Such a measure is the _ _ _ _ _ _ _ _
With the tax shelter benefits available in real estate investment, some investors prefer an equity return measure derived on an after-tax basis. Such a measure is the cash on cash return (C on C).
The cash on cash return is the ratio of the _ _ _ _ _ _ _ _ to the investor’s _ _ _ _ _ _ _ _.
The cash on cash return is the ratio of the after-tax cash flows (ATCF) to the investor’s original equity investment.
What is the formula for C on C Return?
C on C = ATCH ÷ Equity Investment
How is ATCF calculated?
ATCF = NOI − debt payments − income tax
NOTE ONLY
To judge the profitability (or attractiveness) of the investment, the equity owner must compare the present value of the initial equity and the total present value of a stream of cash flows from operation and disposition.
The operating and reversion cash flows are first discounted at the opportunity cost of equity capital — the expected after-tax rate of return on an equity investment of a similar nature in terms of risk, size, and liquidity of investments. Then the present value of these cash flows (PVCF) must be compared with the initial equity (E0).
If the present value of the cash flows is greater than the investment E0, the investor receives a return greater than the opportunity cost of capital. In this case, the investment is more profitable than a comparable investment, which could be undertaken and would yield only the opportunity cost of capital.
In other words, if the net present value is positive, the project should be undertaken. It can further be concluded that this project will yield a return greater than could be obtained from a comparable investment (opportunity cost). The “value” of this project to the investor can be derived, i.e., the maximum price the investor should be willing to pay to obtain a return at least equal to the discount rate. The maximum bidding price will be defined as the justified investment price (JIP).
NOTE ONLY
To judge the profitability (or attractiveness) of the investment, the equity owner must compare the present value of the initial equity and the total present value of a stream of cash flows from operation and disposition.
The operating and reversion cash flows are first discounted at the opportunity cost of equity capital — the expected after-tax rate of return on an equity investment of a similar nature in terms of risk, size, and liquidity of investments. Then the present value of these cash flows (PVCF) must be compared with the initial equity (E0).
If the present value of the cash flows is greater than the investment E0, the investor receives a return greater than the opportunity cost of capital. In this case, the investment is more profitable than a comparable investment, which could be undertaken and would yield only the opportunity cost of capital.
In other words, if the net present value is positive, the project should be undertaken. It can further be concluded that this project will yield a return greater than could be obtained from a comparable investment (opportunity cost). The “value” of this project to the investor can be derived, i.e., the maximum price the investor should be willing to pay to obtain a return at least equal to the discount rate. The maximum bidding price will be defined as the justified investment price (JIP).
_ _ _ _ _ _ _ is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.
iNTERNAL RATE OF RETURN is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.
The maximum bidding price will be defined as the _ _ _ _ _ _ _
The maximum bidding price will be defined as the justified investment price (JIP).
NOTE ONLY / ALTERNATIVES TO IRR
When there are negative cash flows during an investor’s holding period, there is the potential for multiple rates of return. More than one discount rate may cause the net present value to be equal to zero.
Moreover, in the internal rate of return calculation, there is an implicit assumption that the cash flows during the holding period are re-invested by the investor at a rate equivalent to the derived internal rate of return. In some investment situations this reinvestment assumption may be considered unrealistic.
NOTE ONLY / ALTERNATIVES TO IRR
When there are negative cash flows during an investor’s holding period, there is the potential for multiple rates of return. More than one discount rate may cause the net present value to be equal to zero.
Moreover, in the internal rate of return calculation, there is an implicit assumption that the cash flows during the holding period are re-invested by the investor at a rate equivalent to the derived internal rate of return. In some investment situations this reinvestment assumption may be considered unrealistic.
What are the three different approaches to calculating ARR?
ARR – Adjusted Rate of Return
Reinvestment of all cash flows at a single rate
Reinvestment of positive cash flows at a single rate, and of negative cash flows at a borrowing rate
Borrowing to cover negative cash flows offset against positive cash flows with balance reinveste
