RM 450 Exam 3 with complete solutions
A+ rated
Multi Year Discounted Cash Flow Models - correct answer ✔✔Used to overcome shortcomings of single
year decision making metrics by estimating the holding period, forecast future cash flows (from
operations and sale), as well as select appropriate discount rate
Levered Cash Flows - correct answer ✔✔Measure levered BTCF's rather than the yearly NOI's
Net Present Value - correct answer ✔✔NPV = PVin - PVout
Discount Rate - correct answer ✔✔E(Rj) = r = Rf + RPj
Rf = risk free rate
RPj = risk premium for subject property
Risk Free Rate (Rf) - correct answer ✔✔- yield/return available on US Treasury securities with the
maturity equal to expected holding period of the property
- benchmark rate readily observable
Risk Premium for Subject Property (RPj) - correct answer ✔✔- component of discount rate that is
difficult to determine
High Quality & Relatively Safe RE Investments - correct answer ✔✔6-8% required returns
Safe Development RE Investments - correct answer ✔✔15-30% or more required returns
Why IRR is Technically Inferior to NPV - correct answer ✔✔- IRR may rank investment opportunities
differently than NPV
- NPV ranking is always consistent with wealth maximization
, - If projected cash flows signs more than once over expected holding, there may be numerous IRR's
Effects of Leverage on NPV & IRR - correct answer ✔✔- Increased leverage typically increases both NPV
and IRR, making mortgage rate and all other assumptions constant
- Also increases risk to equity investor, meaning required equity return should increase
Sensitivity Analysis - correct answer ✔✔Consists of the following:
- most likely scenario
- worst case scenario
- best case scenario
- all possible scenarios
Problems with PV and NPV analysis
- questionable assumptions
- possibly wrong assumptions
Can help quantify the consequences of making bad assumptions or using inaccurate estimates
Can typically hold other variables constant
2 Main Types of Sensitivity Analysis - correct answer ✔✔- Change one assumption at a time
- Scenario Analysis
Change One Assumption at a Time - correct answer ✔✔Pros
- Can isolate the effects of assumptions on different variables
Cons
- likely correlated variables
- not all possible outcomes are analyzed
Scenario Analysis - correct answer ✔✔- use different combinations of assumptions
- may not be able to isolate different effects but take into account correlations among variables
A+ rated
Multi Year Discounted Cash Flow Models - correct answer ✔✔Used to overcome shortcomings of single
year decision making metrics by estimating the holding period, forecast future cash flows (from
operations and sale), as well as select appropriate discount rate
Levered Cash Flows - correct answer ✔✔Measure levered BTCF's rather than the yearly NOI's
Net Present Value - correct answer ✔✔NPV = PVin - PVout
Discount Rate - correct answer ✔✔E(Rj) = r = Rf + RPj
Rf = risk free rate
RPj = risk premium for subject property
Risk Free Rate (Rf) - correct answer ✔✔- yield/return available on US Treasury securities with the
maturity equal to expected holding period of the property
- benchmark rate readily observable
Risk Premium for Subject Property (RPj) - correct answer ✔✔- component of discount rate that is
difficult to determine
High Quality & Relatively Safe RE Investments - correct answer ✔✔6-8% required returns
Safe Development RE Investments - correct answer ✔✔15-30% or more required returns
Why IRR is Technically Inferior to NPV - correct answer ✔✔- IRR may rank investment opportunities
differently than NPV
- NPV ranking is always consistent with wealth maximization
, - If projected cash flows signs more than once over expected holding, there may be numerous IRR's
Effects of Leverage on NPV & IRR - correct answer ✔✔- Increased leverage typically increases both NPV
and IRR, making mortgage rate and all other assumptions constant
- Also increases risk to equity investor, meaning required equity return should increase
Sensitivity Analysis - correct answer ✔✔Consists of the following:
- most likely scenario
- worst case scenario
- best case scenario
- all possible scenarios
Problems with PV and NPV analysis
- questionable assumptions
- possibly wrong assumptions
Can help quantify the consequences of making bad assumptions or using inaccurate estimates
Can typically hold other variables constant
2 Main Types of Sensitivity Analysis - correct answer ✔✔- Change one assumption at a time
- Scenario Analysis
Change One Assumption at a Time - correct answer ✔✔Pros
- Can isolate the effects of assumptions on different variables
Cons
- likely correlated variables
- not all possible outcomes are analyzed
Scenario Analysis - correct answer ✔✔- use different combinations of assumptions
- may not be able to isolate different effects but take into account correlations among variables
