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4. You are considering buying an apartment building listed for $1 million, where the expected potential gross income for the first year is $171,000 and expected vacancies are 10 percent the first year and fifth year and 5 percent in the other years. Market rents are estimated to increase by approximately 2 percent in years 1 - 5. In year 5, you expect to introduce some major capital improvements to the property that cost $95,000 and then raise the rents to 6 percent in year 6. Market rents should continue to increase by 2 percent annually in years 7 - 10. Operating expenses are estimated to be 40 percent of the effective gross income. You intend to hold the property for 10 years and expect market appreciation on the purchase price to be approximately 1 percent each year a. Use Excel to set up the cash flows from the property in a pro forma to estimate the NOI each year and copy the table with the above assumptions into your assignment report. Be sure to include all capital expenditures and the cash flow from the reversion sale in Year 10. b. What is the present value of the property if the required return (discount rate) is 10 percent? Given the listed price of $1 million, should you do the deal? Why or why not? (Hint: Use the NPV Decision Rule as well as compare the IRR to the required return of 10 percent.) What is the IRR if you could get the seller to accept $950,000 for the building? What is the NPV at this price? Why does this make sense? c. Suppose that the required return on the property is 9 percent instead of 10 percent. What is the value of the property then? How does the new value compare to the original value you computed in part a? (Note the sensitivity of the value to a small change in the required return by the DCF valuation method.) d. Suppose that the required return on the property remains at 10 percent, but you intend to raise the rents in the 6th year by 10 percent instead of 6 percent and rent increases are 3% annually in Years 7 - 10. Compute the new value of the property. How does it compare to the original value you computed in part a? How does it compare to the value you computed in part c? Which has a greater effect on the present value, decreasing the expected return to 9 percent or raising the rents by 10 percent in the original proposal? Discuss why this makes sense. 4. You are considering buying an apartment building listed for $1 million, where the expected potential gross income for the first year is $171,000 and expected vacancies are 10 percent the first year and fifth year and 5 percent in the other years. Market rents are estimated to increase by approximately 2 percent in years 1 - 5. In year 5, you expect to introduce some major capital improvements to the property that cost $95,000 and then raise the rents to 6 percent in year 6. Market rents should continue to increase by 2 percent annually in years 7 - 10. Operating expenses are estimated to be 40 percent of the effective gross income. You intend to hold the property for 10 years and expect market appreciation on the purchase price to be approximately 1 percent each year a. Use Excel to set up the cash flows from the property in a pro forma to estimate the NOI each year and copy the table with the above assumptions into your assignment report. Be sure to include all capital expenditures and the cash flow from the reversion sale in Year 10. b. What is the present value of the property if the required return (discount rate) is 10 percent? Given the listed price of $1 million, should you do the deal? Why or why not? (Hint: Use the NPV Decision Rule as well as compare the IRR to the required return of 10 percent.) What is the IRR if you could get the seller to accept $950,000 for the building? What is the NPV at this price? Why does this make sense? c. Suppose that the required return on the property is 9 percent instead of 10 percent. What is the value of the property then? How does the new value compare to the original value you computed in part a? (Note the sensitivity of the value to a small change in the required return by the DCF valuation method.) d. Suppose that the required return on the property remains at 10 percent, but you intend to raise the rents in the 6th year by 10 percent instead of 6 percent and rent increases are 3% annually in Years 7 - 10. Compute the new value of the property. How does it compare to the original value you computed in part a? How does it compare to the value you computed in part c? Which has a greater effect on the present value, decreasing the expected return to 9 percent or raising the rents by 10 percent in the original proposal? Discuss why this makes sense

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