Week 6 Seminar (week 5 Content)

Question 1

What is the difference between Internal Rate of Return and Required Rate of Return?

Answer 1

1. IRR

The IRR is simply the discount rate, which, when applied to a series of cashflows, gives a net present value (NPV) of zero.
i.e. NPV(IRR, [cashflows]) = 0

Normally there’s just one IRR however, in some instances, there’s no IRR, sometimes there are two IRR’s (more on this in another article).

2. RRR

The RRR (or hurdle rate) is the return a company requires on its projects in order to proceed with them. This is a fairly arbitrary number and differs from company to company. It is not necessarily related to the cost of funds.

Put another way, if NPV(RRR, [cashflows]) > 0 for a given project then that project passes the required rate of return (RRR) test and may be evaluated further.
If NPV(RRR, [cashflows]) < 0 the project could still be a great project and generate value for shareholders, but it doesn’t pass the company’s required rate of return test.

Question 2

2. What is the difference between Internal Rate of Return and Expected Rate of Return?

Answer 2

Required rate of return is the minimum rate of return which a firm has to earn.
Expected rate of return is that rate of return that a firm expects from the investment.

E.g. to pass an exam students need 45% - this is the required rate of return. But students can expect of 80% from their exam - this is expected rate of return.

Question 3

What is the difference between Net Present Value and Market Value?

Answer 3

Net present value is the present value of all future cash flows produced by a rental property less the amount of initial cash investment required to purchase the investment property. Net present value (NPV) considers the time value of money and therefore is a popular real estate investing rate of return.
Market value is an opinion of what a property would sell for in a competitive market based on the features and benefits of that property (the value), the overall real estate market, supply and demand, and what other similar properties have sold for in the same condition.

Question 4

What is the difference between Net Present Value and Investment Value?

Answer 4

Net present value is the present value of all future cash flows produced by a rental property less the amount of initial cash investment required to purchase the investment property. Net present value (NPV) considers the time value of money and therefore is a popular real estate investing rate of return.
Investment value is the value of a property to a particular investor. It is equal to market value for the investor who has the capacity to put the property to good use—its highest-and-best-use, its most valuable use.