karoliukas

Johnson is considering the purchase of Happy Valley Acres, a 300-unit apartment complex. She has hired Carson, CFA, to advise her on the investment. Carson has estimated the following data for Happy Valley’s next accounting period:

• Potential rental income = $3.80 million.
• Vacancy rate = 3.5%.
• Insurance costs = $250,000.
• Financing costs = $940,000.
• Property taxes = $400,000.
• Utility expense = $120,000.
• Repair costs = $200,000.
• Depreciation = $350,000.
• Required return = 8%.

The property’s net operating income (NOI) and value should be closest to:

NOI

Value

A) $2.83 million $33.75 million

B) $2.70 million $33.75 million

C) $2.70 million $21.60 million

---

NOI = rental income × (1 − vacancy rate) − insurance costs − property taxes − utility expense − repair costs
NOI = $3.80 million × (96.5%) − 250,000 − 400,000 − 120,000 − 200,000 = 2.70 million
Value of building = 2.70 million / 0.08 = 33.75 million

karoliukas

An investor is considering purchasing an office building that is currently 95% leased.

Gross potential rental income	$105,000
Insurance and taxes	$9,000
Repairs and maintenance	$15,000
Depreciation	$11,000

What is the building's net operating income (NOI), based on the above table?

A) $75,750.

B) $64,750.

C) $81,000.

---

NOI can be calculated as gross rental income minus vacancy losses, insurance and taxes, and repairs and maintenance. Depreciation is not a factor in calculating NOI. NOI for the building is $105,000 – ($105,000 × 5%) - $9,000 - $15,000 = $75,750.

karoliukas

All of the following variables might be factors when calculating the net operating income (NOI) for a property EXCEPT:

A) collection losses.

B) insurance.

C) depreciation.

---

Insurance expenses and collection losses for a property are all factors in the NOI calculation. Depreciation is not a factor when calculating NOI because a basic, underlying assumption is that routine repairs and maintenance will keep the property in its existing condition.

karoliukas

The gross rental income for an apartment building allowing for vacancies is $500,000. Estimated expenses total $200,000. If the capitalization rate is 10%, the value of this building using the direct capitalization approach is closest to:

A) $3,000,000.

B) $3,500,000.

C) $2,500,000.

---

NOI = 500,000 − 200,000 = 300,000
MV = NOI / Capitalization rate = 300,000 / 0.10 = 3,000,000

Kingpin804

A real estate analysis estimates the market value of an income-producing property at $2,560,000. The annual gross potential rental income is $596,000, the annual property operating expenses and taxes are $178,800, and the annual vacancy and collection losses are $89,400. What capitalization rate was used by the analysis to assess the property at $2,560,000?

A) 0.1275.

B) 0.1290.

C) 0.1280.

---

MV	=	NOI
		CAP
CAP	=	NOI
		MV

596,000 − 178,800 − 89,400	=	0.128
2,560,000

Kingpin804

An investor made the following purchase:

• Bought an office building for $500,000 using 90% financing.
• The borrowing cost was 10%.
• They received $29,000 at year-end from rentals.
• They sold the building for $520,000 at the end of the year.

Assuming a flat tax rate on income and capital gains of 25% what was the return on equity?

A) +6%.

B) -3%.

C) +10%.

---

Equity = 500,000(0.10) = 50,000
Interest cost = 450,000 (0.10) = 45,000
Capital Gain = 520,000 − 500,000 = 20,000
ATCF = (Income + Capital Gain − Interest)(1 − tax rate)
ATCF = (29,000 + 20,000 − 45,000)(1 − 0.25) = $3,000
ROE = ATCF / Equity = 3,000 / 50,000 = 0.06 or 6%

Kingpin804

Ron Biggs is considering a real estate investment. In the first year, the property is expected to generate revenue of $65,000. The expense in the first year is $25,000 and the depreciation allowance will be 2.6 percent of the $350,000 initial investment. Assuming all cash flows occur at the end of the year and Biggs expects to be in a 35 percent marginal tax bracket, the after-tax cash flow in year 1 is closest to:

A) $30,900.

B) $29,185.

C) $20,085.

---

After-tax cash flow = (revenue – cost – depreciation)(1 – t) + depreciation.
Depreciation = 0.026 × $350,000 = $9,100.
CF = ($65,000 – $25,000 – $9,100)(1 – 0.35) + $9,100 = $29,185.

Kingpin804

A real estate speculator is considering an investment in a piece of raw land that will be developed. He expects to invest $150,000 in the land. It will not be developed for three years, but at the end of year 3, he expects a cash flow of $25,000. In years 4 and 5, the cash flow will increase to $35,000, and at the end of year 5 he expects to sell the land for $185,000. Due to the risky nature of the investment, he requires an 18% return.The net present value of this investment is closest to:

A) -$32,903.

B) $30,222.

C) -$20,568.

---

CF0 = –150,000
CF1 = 0
CF2 = 0
CF3 = 25,000
CF4 = 35,000
CF5 = (35,000 + 185,000) = 220,000
I/Y = 18; CPT → NPV = –$20,567.90

---

The internal rate of return (IRR) is closest to:

A) 12.6%.

B) 18.1%.

C) 14.3%.

---

CF0 = –150,000
CF1 = 0
CF2 = 0
CF3 = 25,000
CF4 = 35,000
CF5 = 220,000
CPT → IRR = 14.3%.

Kingpin804

An investor purchases a property for $1,000,000, financing 92% of the purchase price. He plans to sell the property four years later for $1,200,000. The expected net cash flows for the investment are as follows:

Year 1	$23,450
Year 2	$25,312
Year 3	$27,879
Year 4 (net of mortgage payoff)	$261,450

Assuming a 9% cost of equity, the net present value (NPV) of the cash flows at the time the property is purchased is:

A) $169,564.

B) $338,091.

C) $249,564.

---

The present value of the cash flows is: $23,450 / 1.09 + $25,312 / 1.092 + $27,879 / 1.093 + 261,450 / 1.094 = $249,563.83. The NPV is the present value of the cash flows minus the initial investment: $249,564 – $80,000 = $169,564.

Kingpin804

An investor purchases an office building for $2,500,000. He puts 10 percent down and finances the remainder at a 9 percent rate of interest. Calculate the first year’s after-tax cash flow for the investment using the following information:

NOI	$243,000
Depreciation	$25,000
Annual mortgage payment	$218,000
Marginal income tax rate	28%

A) $11,160.

B) $18,000.

C) $20,660.

---

The first year’s interest payment is the amount borrowed ($2,250,000) times the rate of interest (9%), which equals $202,500. After-tax net income, which is NOI minus depreciation minus interest, net of taxes, is ($243,000 - $25,000 - $202,500) × (1 - 0.28) = $11,160. After-tax cash flow is after-tax net income, plus depreciation and minus the principal component of the mortgage payment ($218,000-$202,500): $11,160 + $25,000 - $15,500 = $20,660.