You are considering the purchase of an apartment complex. The following assumptions are made:
- The purchase price is $1,000,000.
- Potential gross income (PGI) for the first year of operations is projected to be $171,000.
PGI is expected to increase at 4 percent per year.
- No vacancies are expected.
- Operating expenses are estimated at 35 percent of effective gross income. Ignore capital expenditures.
- The market value of the investment is expected to increase 4 percent per year.
- Selling expenses will be 4 percent.
- The holding period is 4 years.
- The appropriate unlevered rate of return to discount projected NOIs and the projected NSP is 12 percent.
- The required levered rate of return is 14 percent.
- 70 percent of the acquisition price can be borrowed with a 30-year, monthly payment mortgage.
- The annual interest rate on the mortgage will be 8.0 percent.
- Financing costs will equal 2 percent of the loan amount.
- There are no prepayment penalties.
a. Calculate the levered required initial equity investment.
b. Calculate the before-tax cash flow (BTCF) for each of the four years.
c. Calculate the before-tax equity reversion (BTER) from the sale of the property.
d. Calculate the levered net present value of this investment. Should you purchase? Why?