You are an employee of University Consultants, Limited, and have been given the following assignment. You are to present an investment analysis of a small retail income-producing property for sale to a potential investor. The asking price for the property is $1,430,000; rents are estimated at $183,040 during the first year and are expected to grow at 2.5 percent per year thereafter. Vacancies and collection losses are expected to be 10 percent of rents. Operating expenses will be 35 percent of effective gross income. A fully amortizing 70 percent loan can be obtained at 8 percent interest for 30 years (total annual payments will be monthly payments × 12). The property is expected to appreciate in value at 4 percent per year and is expected to be owned for five years and then sold. Required: a. What is the first-year debt coverage ratio? b. What is the terminal capitalization rate? c. What is the investor's expected before-tax internal rate of return on equity invested (BTIRR)? d. What is the NPV using a 14 percent discount rate? e. What is the profitability index using a 14 percent discount rate?
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
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