gproperty could be sold today (year O) to provide an after-tax cash flow from sa
ID: 2807082 • Letter: G
Question
gproperty could be sold today (year O) to provide an after-tax cash flow from sale of $800, cash flow from o of $824,000 from the sale 000. If sold next year (year 1), the property is expected to generate after-tax w o oations of $24,000 and additionally provide an after-tax cash flow (A) What is the marginal rate of return for holding the property for an additional year and selling at the end of year 1? 824 000 + 20000x | +0,04%))-900 ,000 5.6 (B) As an alternative, the owner can instead forgo the sale and instead improve the property by investing $50,000 in year 0. That will increase the after-tax cash flow from operations to $50,000 per year. A sale at the end of year 3 will generate after tax cash flow from sale of $1,000,000. What is the internal rate of return (IRR) under this scenario?Explanation / Answer
(A) The marginal rate of return for holding the property for an additional year and selling it at the end of year
= (After-tax cash flow from sale at year 1+ After tax cash flow from operations during the year - After-tax cash flow from sale at year 0)/ After-tax cash flow from sale at year 0
= ($824,000 + $24,000 - $800,000)/ $800,000
= $ 48,000 / $800,000
=0.06 or 6%
(B) Assume that property is hold for 3-years
Year
Initial After-tax Cash Flow from Property (A)
Additional After-Tax cash flow from property (B)
After-tax cash flow from sale at year 3 (C )
Total after-tax cash flow (A+B+C)
0
($800,000)
($50,000)
($850,000)
1
$24,000
$50,000
$74,000
2
$24,000
$50,000
$74,000
3
$24,000
$50,000
$1,000,000
$1,074,000
IRR
13.84%
The internal rate of return (IRR) is 13.84% [you can use excel also to calculate IRR “=IRR (cash flow values)”]
OR
You can use following formula to calculate internal rate of return (IRR)
Sum of [cash flows/ (1+IRR) ^t] - initial cash outflow = 0
Where,
Initial Outflow of Cash = -$850,000
Internal Rate of Return is IRR =?
Therefore
$74,000/ (1+IRR) ^1 + $74,000/ (1+IRR) ^2 + $1,074,000/ (1+IRR) ^3 - $850,000 = 0
By trial and error method, we get
The internal rate of return (IRR) = 13.84%
Year
Initial After-tax Cash Flow from Property (A)
Additional After-Tax cash flow from property (B)
After-tax cash flow from sale at year 3 (C )
Total after-tax cash flow (A+B+C)
0
($800,000)
($50,000)
($850,000)
1
$24,000
$50,000
$74,000
2
$24,000
$50,000
$74,000
3
$24,000
$50,000
$1,000,000
$1,074,000
IRR
13.84%
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