CHAPTER 20
Investment Decisions: NPV and IRR
Test Questions
1.
A real estate investment is available at an initial cash outlay of $10,000, and is
expected to yield cash flows of $3,343.81 per year for five years.
The internal
rate of return (IRR) is approximately:
b. 20 percent.
2.
The net present value of an acquisition is equal to:
b. the present value of expected future cash flows, less the initial cash outlay.
3.
Present value:
b. is the value now of all net benefits that are expected to be received in the
future.
4.
The internal rate of return equation incorporates:
d. initial cash outflow and inflow, and future cash outflow and inflow.
5.
The purchase price that will yield an investor the lowest acceptable rate of return:
a. is the property’s investment value to that investor.
6.
What term best describes the maximum price a buyer is willing to pay for a
property?
a. investment value
7.
An incomeproducing property is priced at $600,000 and is expected to generate
the following aftertax cash flows:
Year 1: $42,000; Year 2: $44,000; Year 3:
$45,000; Year 4: $50,000; and Year 5:
$650,000.
Would an investor with a
required aftertax rate of return of 15 percent be wise to invest at the current
price?
b. No, the NPV is $148,867.
8.
As a general rule, using financial leverage:
b. increases risk to the equity investor.
9.
What is the IRR, assuming an industrial building can be purchased for $250,000
and is expected to yield cash flows of $18,000 for each of the next five years and
be sold at the end of the fifth year for $280,000?
c. 9.20 percent
201
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
10.
Given the following information, what is the required equity investment due at
closing?
• Acquisition price: $800,000
• Loantovalue ratio: 75%
• Financing cost: 3%
c. $218,000
Study Questions
1.
List three important ways in which DCF valuation models differ from direct
capitalization models.
Solution
: Direct capitalization models require an estimate of stabilized income for
one year.
DCF models require estimates of net cash flows over the entire
expected holding period.
In addition, the cash flow forecast must include the net
cash flow expected to be produced by the sale of the property at the end of the
expected holding period.
Finally, the appraiser must select the appropriate yield
(required IRR) at which to discount all future cash flows or to use as the hurdle
rate in an IRR analysis.
2.
Why might a commercial real estate investor borrow to help finance an
investment even if she could afford to pay 100 percent cash?
Solution
: Borrowingi.e., the use of “other people’s money”—is also refereed to
as the use of financial leverage.
If the overall return on the property exceeds the
cost of debt, the use of leverage can significantly increase the rate of return
investors earn on their invested equity.
This expected magnification of return
often induces investors to partially debt finance even if they have the accumulated
wealth to pay all cash for the property. Other potential benefits of leverage
This is the end of the preview.
Sign up
to
access the rest of the document.
 Spring '08
 PENG,LIANG
 Net Present Value, Internal rate of return, Basic financial concepts

Click to edit the document details