Sally and Dave—fresh out of business school with a little cash to spare—are cons

Question

Sally and Dave—fresh out of business school with a little cash to spare—are considering buying a nifty condo as a rental property. The condo will cost $100,000, and (in this example at least) they’re planning to buy it with all cash. Here are some additional facts:

- Sally and Dave figure they can rent out the condo for $25,000 per year. They’ll have to pay property taxes of $1,500 annually and they’re figuring on additional miscellaneous expenses of $1,000 per year.

- They can depreciate the full cost of the condo over 10 years using straight line depreciation method.

- All the income from the condo has to be reported on their annual tax return. Currently Sally & Dave have a tax rate of 30%, and they think this rate will continue for the foreseeable future.

- They assume that at the end of the 10 years they’ll be able to sell the condo for $80,000.

- The appropriate discount rate is 12% and the reinvestment rate is also 12%.

1) Calculate Sally and Dave’s Condo Investment Project’s NPV and IRR.

2) Calculate Sally and Dave’s Condo Investment Project’s MIRR and Profitability Index

3) What is Sally and Dave’s Condo Investment Project’s Pay Back Period?

4) What is Sally and Dave’s Condo Investment Project’s Discounted Pay Back Period?

Excel if possible

Explanation / Answer

Calculation of operating cash inflow for each of first 10 years:-

Gross income

(-) Property tax and miscellaneous expenses (1500 + 1000)

25000

2500

Earnings before depreciation

(-) Depreciation (100000 / 10)

22500

10000

Earning before tax

(-) tax @ 30 %

12500

3750

Earnings after tax

(+) depreciation

8750

10000

1) NPV = P.V. of cash inflow - P.V. of cash outflow

P.V. of cash inflow =18750 * Cumulative P.V. factors for 10 Years @ 12 % + 80000 * P.V. factor for 10TH year @ 12 %

   = 18750 * 5.650 + 80000 * 0.322

   = $ 131697.50 (approx)

   NPV = 131697.50 - 100000 = $ 31697.50

2) profitability index = P.V. of cash inflow / P.V. of cash outflow = 131697.50 / 100000 = 1.316975 (approx)

3) Payback period = intial investment / Annual cash inflow = 100000 / 18750 = 5.33 Years

4) Discounted payback period =

Discounted pay back period = 9 + (100000 - 99900) / 31797.50

   = 9 + 100 / 31797.50

   = 9 + 0.003 = 9.003 [Approximately 9 Years]

Conclusion:-

Particulars In $

Gross income

(-) Property tax and miscellaneous expenses (1500 + 1000)

25000

2500

Earnings before depreciation

(-) Depreciation (100000 / 10)

22500

10000

Earning before tax

(-) tax @ 30 %

12500

3750

Earnings after tax

(+) depreciation

8750

10000

Operating cash inflow 18750

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