Directions
Worksheet – IRR, NPV and Equity Multiple (Please show all work)
Katie Scarlett is analyzing the same 15-unit apartment building for a client for possible purchase. She expanded her analysis from just the DCF (Income) to include the Direct Cap (Income), the Cost and the Market approaches to value. Remember she estimated the gross potential rents are $250,000 in Year 1 and are expected to grow 5% for through Year 3 and then by 3% starting in Year 4 as new supply comes on line. There is currently no vacancy, but vacancy is expected to increase to 3.0% as the new supply comes into the market. Notwithstanding that expectation, Katie assumes a more typical vacancy and credit risk of 5% for all periods. She refines her estimate for expenses since they run more inline with 45% of Effective Gross Income at Year 1 and will grow independently (from the base amount of expenses, not the percentage rate) at the inflation rate 3% per year.
She analyzed the replacement costs in the market and they are approximately $155,000/unit including cost of land. She identifies three sales comparables of similar apartment properties in the market that have sold within the last 6 months. Based on these recent sales, the average cost is $140,000/unit. The average cap rate is 6.5%
Katie is going analyze the investment on a 5-year hold. The client wants Katie to refine the bid price to take into consideration both the cost and market approach to value. They also want to see the NPV, IRR and Equity Multiple on this potential investment.
1. Katie reruns the DCF return. The market is assuming the discount rate to be 8% and the reversion (aka terminal or exit) cap rate is estimated to be 7%. What is the new DCF Katie calculates? Hint: the reversion value is based off of Year 6 NOI.
2. What is the estimate of value using the Direct Cap (Income)?
3. To arrive at the refined bid price, Katie weights the Cost Approach 10%, the Market Approach 30%, Direct Cap 20% and the DCF 40%. What is the bid price Katie presents to the client.
4. Katie knows that the projected IRR is calculated from the bid price, estimated NOIs and Reversion Value less 4% transaction costs. What is the IRR Katie calculates? What is the NPV? We are looking for a net calculation, that is, a comparison against the discount rate, not a standalone view of IRR and NPV because the client needs the information presented as a “make the investment or not” calculation.
5. Katie’s client also wants to know the equity multiple for the investment. What is the equity multiple Katie calculates?
What to Include
If you use a spreadsheet, include formulas and submit Excel file.
If you solve on paper, show the work you completed to arrive at your answer.
