Question

An investor is considering the acquisition of a “distressed property” which is on Northlake Bank’s REO list. The property is available for $200,000 and the investor estimates that he can borrow $160,000 at 8 percent interest and that the property will require the following total expenditures during the next year:

Inspection	$      500
Title search	1,000
Renovation	13,000
Landscaping	800
Loan interest	12,800
Insurance	1,800
Property taxes	6,000
Selling expenses	8,000

1. The investor is wondering what such a property must sell for after one year in order to earn a 20 percent return (IRR) on equity. What other issues must he consider?

Answer 1

SOLUTION:-

An investor wants to purchase a property today for the value of $200,000. The investor can borrow $160,000 at 8% interest. The property has various expenditures related to it during the next year. The investor wants to earn 20% return on equity. He wants to know the value at which the property can be sold after a year in order to earn 20% internal rate of return. Step 1: Calculate the acquisition fees as follows: Acquisition Fees Title search Inspection Property taxes Total Amount $1,000.00 $500.00 $6,000.00 $7,500.00

Step 2: Calculate the renovation costs as follows: Renovation costs Amount Renovation $13,000.00 Landscaping $800.00 Loan interest $12.800.00 Insurance $1.800.00 Total $28,400.00

Step 3: Calculate the equity value as follows: Amount $200,000.00 $7,500.00 Particulars Purchase price Add: Acquisition fees Less: Loan amount Equity amount $160,000.00 $47,500.00

Here, the payment amounts for the renovation costs i.e. $28,400. Interest rate is 20% compounded annually for a year and present value is the equity amount i.e. $47,500. Calculate the future value or net cash flow needed in year for sale using financial calculator as follows: Input values PV = -47,500 PMT = -28.400 I= 20% Solve for FV FV = 85,400 Therefore, the net cash flow needed in year for sale is $85,400 Note: The spreadsheet input to compute the future value would be = FV (20%, 1.-28400,-47500,0)

Calculate the value at which the property can be sold after a year in order to earn 20% internal rate of return as follows: Sale value = Net cash flow needed in year for sale + Loan amount + Selling expenses = $85,400 + $160,000+ $8,000 = $253,400 Therefore, the value at which the property can be sold after a year in order to earn 20% internal rate of return is $253,400