Question

You are considering an investment into an income producing property (let’s call it Property A). The acquisition price is $227,500 and you can finance it with a 70% loan to value ratio mortgage with a 6% annual interest rate. This will be a fixed-rate mortgage with constant monthly

The broker provides you with the following (incomplete) information about Property A. You determine that you will make this investment if it yields an after-tax internal rate of return on equity which is greater than 12%.

You determine that you will hold Property A for three years and then sell at the end of year 3.

The annual depreciation deduction you can claim on the property is $5,833.

You do not expect to make any capital expenditures.

The incomplete pro-forma for Property A appears below. Incomplete sections of the pro-forma are shaded grey.

Loan Terms

Acquisition Price	$227,500	(100% of the acquisition price attributed to the structure)
Loan to value ratio	70%
Loan Amount	$159,250
Interest Rate	6%	Annual Rate; Monthly compounding
Term to maturity; Amortization Term	30	years

Additional Assumptions

Annual Depreciation Deduction	$5,833	(Assuming Straight line depreciation 39 years)
Ordinary Tax Rate	30%
Going-out capitalization rate	10.25%

Year 1 2 3

Effective Gross Income	$35,000	$36,050	$37,132
less: Operating Expenditure	$ (12,250)	$(12,618)	$(12,996)
less: Capital Expenditure	$0	$0	$0
Net Operating Income	$22,750	$23,433	$24,135
less: Debt Service	$ (11,457)	$(11,457)	$(11,457)
Before Tax Cash Flow (Operations)	$11,293	$11,975	$12,678
less: Tax Liability	(A)	$(2,465)	$(2,715)
After Tax Cash Flow (Operations)	(B)	$9,510	$9,963
After Tax Cash from Sale			$82,888
Total After Tax Cash Flow	(C)	$9,510	$92,852

Find the Tax Liability for Year 1 (ANSWER) , after tax cash flows from operations for Year 1 (ANSWER) , and Total After Tax Cash Flow for Year 1 (ANSWER)

Answer 1

Effective Gross Income	$35,000	$36,050	$37,132
less: Operating Expenditure	$ (12,250)	$(12,618)	$(12,996)
less: Capital Expenditure	$0	$0	$0
Net Operating Income	$22,750	$23,433	$24,135
less: Debt Service	$ (11,457)	$(11,457)	$(11,457)
Before Tax Cash Flow (Operations)	$11,293	$11,975	$12,678
less: Tax Liability	$ (3388)	$(2,465)	$(2,715)
After Tax Cash Flow (Operations)	$ 7905	$9,510	$9,963
Add : Depreciation	$ 5833	$ 5833	$ 5833
After Tax Cash from Sale	$ 13738	$ 15343	$82,888
Total After Tax Cash Flow	$ 13738	$ 15343	$ 98684

Assuming that Operating expenditure includes depreciation expenses of $ 5833 and it should be added back to after tax cash flow for realsing actual cash flow from operations. Since Depreciation is not a cash expenses and it is considered only for tax purposes.