Quiz 19: Investment Decisions: Npv and Irr
Direct capitalization models require an estimate of stabilized income for one year.DCF models require estimates of net cash flows over the entire expected holding period.In addition, the cash flow forecast must include the net cash flow expected to be produced by the sale of the property at the end of the expected holding period.Finally, the appraiser must select the appropriate yield (required IRR) at which to discount all future cash flows or to use as the hurdle rate in an IRR analysis.
IRR (Internal Rate of Return) of project is the rate at which the NPV (Net Present Value) of project becomes zero.. It is simple to apply. The project which has IRR greater than its required rate of return should be accepted. The IRR can be computed using the "IRR" function of spreadsheet Compute the "IRR" using the spreadsheet. Enter given values and formula in the spreadsheet as shown in the image below. Obtained result is provided below. Thus, the internal rate of return is . Therefore, the correct answer is .
Borrowing--i.e., the use of "other people's money"-is also refereed to as the use of financial leverage. If the overall return on the property exceeds the cost of debt, the use of leverage can significantly increase the rate of return investors earn on their invested equity. This expected magnification of return often induces investors to partially debt finance even if they have the accumulated wealth to pay all cash for the property. Other potential benefits of leverage include: the ability to break through equity capital constraint in order to acquire more + NPV projects; the ability to apply the owner/operator's comparative advantage in acquisition and management to more projects; and increased portfolio diversification.