Calculation of npv of lease payments

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Reference no: EM1310979

Calculation of NPV of lease payments and capital contribution decision to the lease project proposed.

1) You represent a REIT which is considering purchasing a certain lease. You are evaluating the potential transaction using the following given information:

Lease term: Perpetual.

Tenant: Investment grade commercial tenant. This tenant just issued a perpetual bond at a 6% yield (interest rate).

• No capital expenditures necessary, absolute triple net (NNN) lease.

• Rent is fixed at $1,000 per year, payable annually on 12/31.

• Your company has access to perpetual debt at 7%.

• Your company has a corporate WACC of 8% based on 50% debt/total value with 7% cost of debt and 9% target return on stockholder equity. (Recall that REITs are exempt from corporate-level income taxes.)

• Market yields in the municipal (tax-exempt) bond market for perpetual debt of similar risk to the lease are currently 4.5%.

a. What discount rate would you use to determine the market value (MV) of this lease (what your company would have to bid to obtain it)? What is the PV of the lease at that discount rate? (Show your work.) Why is it correct to use the discount rate you selected?

b. Suppose the marginal personal tax rate on investment earnings applicable to marginal investors in your REIT's equity shares (traded in the stock market) is 35%. (Note that REITs are not subject to the 15% limit on dividend taxes.) What discount rate would you use to determine the investment value (IV) of this lease for your REIT (i.e., the likely effect on your REIT's equity value in the stock market)? What is the PV of the lease at this discount rate?. Why did you select the cash flow level and the discount rate that you used?

c. Based on YOUR answers in (a) and (b) (whether those answers are right or wrong), should your REIT be buying, or selling, such leases? Why?

2) Suppose market rate apartments produce net cash flow of $10,000/yr in perpetuity, while affordable units provide only $5,000. However, if the developer commits that 25% of the units will be forever affordable, then she will qualify for a perpetual loan $4,375,000 at an interest rate 50 basis points (0.5%) below the market interest rate. (I lowever, this is not a tax-exempt loan - its interest is taxable.) Also, the developer can receive perpetual (and transferable) annual Low Income Housing Tax Credit (LIHTC) equal to $1,000/yr per low-income unit. If property yields (total returns, opportunity cost of capital) are 10% at the PBT level (assume same for market and affordable apartments), loan market interest rates before-tax are 5%, yields on otherwise similar municipal bonds (tax-exempt loans) are 4%, and the developer faces an income tax rate on investment returns of 20%, then should the developer make her 100-unit apartment complex a mixed-income affordable development or a 100% market development? Tell why, and how much difference it makes (i.e., evaluate the two alternatives). Answer this question from a market value (MV) perspective (but be careful: the LIHTCs are after-tax cash flows).

Reference no: EM1310979

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