Question

You bought a piece of land at $1,000,000. You plan to build a 50,000 square foot building at cost of $100 per square foot, all inclusive, in addition to land cost. The completed building is expected to generate a monthly rent of $1.10 per square foot per month for year 1 and the rent will increase at 5% per year operating expenses will be 0.35 per square foot per month for year 1 and increase at 3% per year. At end of year 10, you plan to sell the property for $7,500,000. Assuming you will have an income tax rate of 30% every year and you will take depreciation charge every year based on the IRS allowed schedule of 1/39h of the building cost only per year. Your capital gain tax rate is 20%. Part 1 Assuming all cash investment and using a MARR of 12%, what is the Net Present Value of this 10-year investment and what is the IRR? Show the results as formatted below: Operating Expense Taxable lincome Tag e30% tax rate Also clearly show the calculations of cach year's Depreciation Charges, Cash Flow After Tax at Ycar 10 for selling of the property and calculations of the present value and IRR Part 2 Assuming you will obtain a bank loan of 75% of the initial cost at an interest rate of 5.50% per year payment only at end of each year and the loan principle is due at end of the 10h year (like a bond arrangement). Everything else stays the same as Part 1 except interest expenses are tax deductible. Re-calculate everything as you did in Part I Based on the result of Part 2 and an Incremental IRR analysis, make your recommendation as which way to go, Part 1 or Part 2 and explain how does financial leverage affect your decision in relation to the selection of this project? The loan requires interest
part 2 only please

Answer 1

Solution:

Given that the following information about

Price of land= $,1,000,000

Tax rate= 30% Discount Rate=7.13%

Part 2	Weight	rate	product
Cost of capital	25%	12%	3%
Loan	75%	5.50%	4.13%
Weighted average discount rate			7.13%
Computation of Net Present Value
Discount rate	7.13%
Tax rate	30%
Particulars	year	Cash flows	Depreciation on building	tax benefit on depreciation	tax expense on PBT	tax benefit on profit on sale of asset	after total cash flows	pv factor	present value
Initial investment	0	-6,000,000					-6,000,000	1.00000	-6,000,000
Netcash inflow before tax	1	450,000	128,205	38,462	-135,000		353,462	0.93349	329,953
Netcash inflow before tax	2	476,700	128,205	38,462	-143,010		372,152	0.87140	324,293
Netcash inflow before tax	3	504,861	128,205	38,462	-151,458		391,864	0.81344	318,758
Netcash inflow before tax	4	534,560	128,205	38,462	-160,368		412,653	0.75934	313,344
Netcash inflow before tax	5	565,877	128,205	38,462	-169,763		434,576	0.70884	308,045
Netcash inflow before tax	6	598,898	128,205	38,462	-179,669		457,690	0.66169	302,849
Netcash inflow before tax	7	633,712	128,205	38,462	-190,114		482,060	0.61768	297,759
Netcash inflow before tax	8	670,413	128,205	38,462	-201,124		507,750	0.57660	292,769
Netcash inflow before tax	9	709,099	128,205	38,462	-212,730		534,831	0.53825	287,873
Netcash inflow before tax	10	749,874	128,205	38,462	-224,962		563,374	0.50245	283,067
proceeds from sale	10	7,500,000				-756,410	6,743,590	0.50245	3,388,317
Total		7,393,994	1,128,051	384,615	1,768,198	-756,410	5,254,001		447,027
							IRR= 7.6%
Since NPV is positive in part 2, the company should accept Option 2