Reference no: EM132766684

Question - Mabuse is considering investing in a 135,000 square foot office building near Randburg, Johannesburg. Market rents in this area are expected to average R9.50 per square foot, increasing by 2.00 percent per year for the foreseeable future. The average vacancy rate for similar office space is 15 percent, and the operating expense ratio for the building is 40 percent of Effective Gross Income (EGI). The tax assessor's office currently estimates the value of the building to be R6 million, with R1 million of this value attributable to land. Mabuse expects that he can purchase this building for R4.8 million, with acquisition costs of 3 percent of the purchase price (embed acquisition costs in Loan).

Financing is available for up to 75 percent of the purchase price, with a 5-year balloon loan, 7.25 percent interest, monthly payments amortized over 20 years, and 1.5 percent of loan borrowed is closing costs (embed closing cost to loan).

The property will be put in service on January 1, 2019. The expected holding period is 5 years (expected sale date of December 31, 2023), at which time it will be sold at a 12 percent cap rate (based on projected NOI for 2024). Transaction costs at the time of sale are expected to be 7 percent of the gross sale price.

Mabuse is at the 35% tax rate on ordinary income, 5% annual depreciation allowance on property and 15 percent for long-term capital gains.

Required -

(i) Calculate expected first-year NOI for this property. At what cap rate is Mabuse purchasing this property? What is the before-tax cash flow for this property? What is Mabuse's cash-on-cash return?

(ii) Calculate the before-tax cash flow for this property for the FIRST YEAR ONLY!!! Clearly label each of the elements required to derive before- tax income and show your workings. Remember, I can only give partial credit if I can follow what you have done.

(iii) Assume that projected NOI for the sixth year is R646,136. Calculate the before-tax reversion from the sale of this property at the end of year 5. Once again, clearly label each of the figures you calculate to derive these figures.

(iv) If cash flow before taxes from operations in years 2 through 5 will be R178,486, R183,900, R189,294, and R192,991, calculate the before-tax NPV of this investment at a 14 percent discount rate. What is the before-tax IRR of this investment? Based on this analysis, is this a worthwhile investment for Mabuse?