1. Lecture 12
Cash Flow Analysis

2. Evaluation of Future Investment Performance
TWO INITIAL FACTORS TO BE ANALYZED:
1. Holding Period
Many assume 10-year for simplicity
Established at the time the investor is analyzing the property
Most investors recalculate holding periods, and compare to initial evaluation

3. Evaluation of Future Investment Performance
If a 10-year holding period is not assumed, an investor viewing periodic cash flow as their investment objective could consider the following:
Link the holding period to a certain time/event in which the funds would be required
Hold the property while BTCF growth occurs and sell when BTCF stabilizes
Hold the property as long as BTCF is positive
Hold the property as long as tax sheltering occurs

4. Evaluation of Future Investment Performance
If a 10-year holding period is not assumed, an investor viewing price appreciation as their investment objective would choose a holding period equal to the time required for anticipated future benefits to occur (selling time).
Anticipated market price increases
Increases in neighboring values in the future
Beneficial changes in future uses

5. Evaluation of Future Investment Performance
TWO INITIAL FACTORS TO BE ANALYZED:
2. Discounting Interest Rate
Investors expected rate of return (easiest, most utilized)
Cost of Capital (interest rate plus risk factor)
Capitalization Rate
Utilized to estimate future appreciated values, based on one income stream
Direct Capitalization

6. Discounted Cash Flow Analysis (Net Present Value)
Lecture 12
Discounted Cash Flow Analysis
(Net Present Value)

7. Process of a Discounted Cash Flow Analysis for Net Present Value
1. Determine BTCF’s
2. Determine Before Tax Equity Reversion
- Proceeds from sale after deducting loan balances and selling costs
3. Discount BTCF’s and BTER
4. Calculate Present Values of BTCF’s and BTER, and sum
5. Net Initial Equity to derive Net Present Value of the Investment

8. Step 1: Before-Tax Cash Flows
Potential Gross Income (PGI)
Less: Vacancy/Collection Loss Allowance
Effective Gross Income (EGI)
Less: Operating Expenses, Management Fees, Cap. Impvt. Allow.
Before Debt Net Operating Income (NOI)
Less: Debt Service
Before-Tax Cash Flow (BTCF)

9. Step 2: Before-Tax Equity Reversion
Utilize Direct Capitalization to estimate value (selling price) at end of holding period
Formula: NOI for year immediately following holding period, divided by market-supported capitalization rate
2. Estimate selling and closing costs (broker commissions, prepayment penalties)
3. Calculate remaining loan balance (determines “net proceeds from sale”)

10. Step 2: Before-Tax Equity Reversion
Estimated Appreciated Value
Less: Selling/Closing Costs
Net Proceeds From Sale
Less: Unpaid Mortgage Loan Balance
Before-Tax Equity Reversion (BTER)

11. Step 3: Discount BTCF’s and BTER
Formula to calculate discounting factors:
PV = 1 / (1 + i)n
i = interest rate
n = holding period

12. Step 3: Discount BTCF’s and BTER
Discount factors, assuming a 10% rate and a 5-year holding period:
Year One: .9091
Year Two: .8265
Year Three: .7513
Year Four: .6830
Year Five: .6209
Year Six: .5645

13. Step 4: Calculate Present Values of BTCF’s and BTER
Formula to calculate present values:
PV BTCF’s = Each BTCF * Discount Factors
PV BTER = BTER * Discount Factor for year immediately following end of holding period
Sum all discounted BTCF’s and BTER to derive Present Value of the Property

14. Step 5: Net Present Value
Present Value of Property
Less: Initial Equity Invested
Net Present Value (NPV)

15. Investment Decision Criterion for NPV
If the following statements are true after your analysis, then the project is a feasible investment:
(PV of all BTCF’s) + (PV of BTER) > Initial Equity Invested
[(PV of all BTCF’s) + (PV of BTER)] - Initial Equity Invested > 0