Suppose you have developed the following information for a potential investment:
current market value is $1,200,000; anticipated loan to value ratio is .80 with 2
points; and predicated cash flows of ATCF1 = $38,560, ATCF2 = $41,780, ATCF3 =
$37,210, ATCF4 = $39,127, and ATER4 = $191,730. Further, assume the investor's
minimum required after-tax rate of return on equity is 12%.
a. What is the internal rate of return on this potential investment?
b. What is the profitability index on this investment?
| Total market value | 1200000 | |||||
| Loan to value ratio | 0.80 | |||||
| Debt value | 960,000.00 | |||||
| Equity of investor | 240,000.00 | |||||
| Year | 0 | 1 | 2 | 3 | 4 | |
| Cash flows | -240,000.00 | 38560 | 41780 | 37210 | 39127 | |
| Terminal cash flow | 191730 | |||||
| Total cash flow | -240,000.00 | 38,560.00 | 41,780.00 | 37,210.00 | 230,857.00 | |
| a | Internal rate of return | 12.14% | It is that rate of return at which the Net present value of all the above cash flows becomes 0. | |||
| Calculated using IRR formula and above cash flows in excel | ||||||
| Required rate of return | 12% | |||||
| b | Present value of cash flows | 240,934.47 | ||||
| Initial investment | 240000 | |||||
| Profitability Index | 1.004 | (Present value of cash flows/Initial Investment) | ||||
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