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Chapter 19 Investment Decisions: NPV and IRR

Chapter 19 Investment Decisions: NPV and IRR. REAL ESTATE FIN 331. Investment Valuation versus Market Valuation. Most commercial real estate decisions involve investment motive Investments are made in expectation of future cash flows

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Chapter 19 Investment Decisions: NPV and IRR

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  1. Chapter 19Investment Decisions: NPV and IRR

    REAL ESTATE FIN 331
  2. Investment Valuation versus Market Valuation Most commercial real estate decisions involve investment motive Investments are made in expectation of future cash flows The magnitude and timing of future cash flows will determine whether or not an investment is profitable or not The Discounted Cash Flow method (DCF) is used to determine the feasibility of an investment Required inputs for DCF analysis Estimate how long the investor will hold the property Estimate the yearly net cash flows Select an appropriate risk-adjusted discount rate to complete the calculations DCF process will yield a net present value (NPV)
  3. Investment Valuation versus Market Valuation NPV decision rules NPV = Present Value of ATCF minus the Initial contact Investment If NPV is greater than 0, we make the investment If NPV is less than 0, we will not make the investment Measuring the impact of leverage Leverage involves the use of debt to finance part of the acquisition The interest charges on debt will reduce our taxable income Traditional analysis uses ATCF values to compute NPV Internal Rate of Return (IRR) When NPVs are greater than 0, the internal rate of return will be greater than the discount rate used to compute NPV if NPV is equal to 0, then the internal rate of return equals the discount rate if NPV is less than 0, then the IRR is less than the discount rate
  4. Measuring the Impact of Risk on NPV Sensitivity analysis Most likely scenario Worst-case scenario Best-case scenario Value of computer Excel spreadsheets Specialized software such as ARGUS Monte Carlo simulation (using random probabilities to develop outcome distributions)
  5. homework assignment Key terms: before tax cash flows, after-tax cash flows, leverage, leverage cash flow, unleveraged cash flow Study questions: 2, 3, 5, 9, 11
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