Discussion in 'Financial Planning Study Group' started by mike_j, 17th Oct, 2010.

1. mike_jNew Member

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17th Oct, 2010
Posts:
3
Location:
queensland
Grace’s current investment property was purchased on 1 July 2010 for \$480,000 in an area that she believes has high growth prospects. She has an interest-only loan of \$350,000 attached to this property. Grace hopes to sell the property in two years time for at least \$575,000. Cash flows from the property are:

Current year (Year 1) Year 2 Year 3
Rent income \$24,960 \$25,709 \$26,352
Less Cash expenses (\$4,295) (\$4,402) (\$4,490)
Net Income \$20,665 \$21,307 \$21,862

Note: In year 2, rent income is expected to increase by 3% compared to year 1 and cash expenses are expected to increase by 2.5% compared to year 1. In year 3, rent income is expected to increase by 2.5% compared to year 2 and cash expenses by 2.0% compared to year 2.
The appropriate discount rate is 7.5%. (The discount rate includes the interest rate for the property loan of 7.2%).

Calculate to the nearest dollar the present value (PV) and net present value (NPV) of Grace’s investment property. Please provide the formula used and all workings.

Ok guys so this is what I am stuck on, it looks of the mark simple but we dont deal with property at all in the new IP1 book, so what is stuffing me up is whether for my first payment I would use the full house costs so \$480,000 or whether to just use the \$350,000 of the loan, or the difference between the two

any help would be great thanks guys

2. RG146TUTORMember

Joined:
17th Oct, 2010
Posts:
5
Location:
Melbourne,VIC
PV and NPV calc

If I understand the question correctly I think the PV just considers the sale price of the property discounted back for the holding period:

PV=FV/(1+r)n

The NPV looks at the sum of the net cash flows discounted back to the present, so your first "net" cashflow is the purchase price minus the loan value. The PV of the first cashflow is not discounted.

Hope this helps

3. serge gActive Member

Joined:
16th Oct, 2009
Posts:
31
Location:
VIC
Treat it like any ther asset

I agree with RG146tutor - from the information you've given, it looks like it doesn't really matter what th asset is, you should be able answer the question with a standard DCF valuation for a series of future cashflows. I expect that's covered in the new edition.

Hope that helps, best of luck.

4. mike_jNew Member

Joined:
17th Oct, 2010
Posts:
3
Location:
queensland
thanks guys.. i think i worked it out.. i was missing the sale of the investment property as a cash flow once I included that things have seemed to work out better