CERTIFICATE PROGRAM

Developed by:

With generous support from:

WEEK 2

PROJECT CASH FLOW AND EVALUATION

COURSE INSTRUCTOR:

Jack S. Nyman

Executive Director, The Steven L. Newman Real Estate Institute

Zicklin School of Business, Baruch College, The City University of New York

WEEK 2: LEARNING OBJECTIVES

Identify revenues and expenses and explain how they are
translated into value.
Apply an understanding of line items, and their impact on cash
flow and value.
Develop a meaningful understanding of cash flow terminology and
notation.
Recognize Creating Value, Generating Efficiency and Saving Money.

Identify and describe the six functions of a dollar.

WEEK 2: READINGS
Readings
The Energy Management Handbook, Chapter 4: Economic
Analysis. Doty & Turner, eds.

Energy Stars Building Upgrade Manual, Chapter 3: Investment

Analysis. US EPA.
Lease-Based Analysis, NYSERDA.

WHAT IS THE TIME VALUE OF MONEY (TVM)?

Basic premise: a dollar today is more valuable than a dollar tomorrow

An investor/lender who provides a dollar today expects a return on that

dollar tomorrow

Economists have developed mathematical formulas to determine the

amount of return that would justify a particular risk

TVM Notation:

n = Number of Periods
r or i = Interest Rate
PV = Present Value
FV = Future Value
PMT = Payment
e$ = Energy Dollar

Source: http://www.investopedia.com/terms/t/timevalueofmoney.asp

TIME VALUE OF MONEY: TERMINOLOGY

1. Annuity a stream of fixed payments, paid or received (usually
received) over a period of time.
Because performing leases yield regular, consistent rent
payments, they may be considered (and treated as) annuities.
2. Interest the amount of Rent paid for the use of anothers money
and for as long as that amount is owed and outstanding.

Simple Interest is not compounded. When calculating the

interest charge, you apply the annual rate of interest to the
original dollar borrowed or invested. Previous interest
periods have no effect and are not applicable when calculating
the present period.

In formula form:
P x I x N = Simple Interest

Author: Sam Irlander, 2014

TIME VALUE OF MONEY: TERMINOLOGY

2.

Interest, continued.

Compound Interest, simply put, it is interest on top of interest.

Each period of accrued interest is added on to the previous base

amount forming a new higher base amount.
The more frequent the compounding periods, the greater the
amount of compound interest yield (monthly adjustment vs. one
annual adjustment)

Nominal Rate The stated rate of interest; no adjustment(s)

made concerning the results of compounding. When the amount
of compounding period(s) differ from the applicable time of
comparison (i.e. 1 month vs. 1 year), the interest rate would be
called nominal rate

Author: Sam Irlander, 2014

TIME VALUE OF MONEY: TERMINOLOGY

2.

Interest, continued.

Annual Percentage Rate commonly referred to as APR. It is a

finance charge that is stated in annual terms rather than lesser
periods (monthly).

When advertising credit terms, disclosures required by

Regulation Z (Truth in Lending/Simplification Act; TILSRA)
include but are not limited to stating the APR
Example:
i.
assume your rate of interest is 10% and your principal is
$1.00
ii. one annual payment would yield $0.10. Now the
investment is worth $1.10
iii. monthly compounded interest would yield $.1047. Now
the investment is worth $1.1047

Author: Sam Irlander, 2014

TIME VALUE OF MONEY: TERMINOLOGY

3.

Principal The dollar amount loaned or spent at acquisition

a.
b.

on loans, it is the present value dollar that is loaned; while

on investments, it is the original dollar expended to purchase the asset

4. Term The period over which a loan is amortized, or for which an

asset is expected to be held (the holding period).
a.

5.

Term can also describe the length of a leasehold.

Maturity The point at which the loan becomes due or payable

a.

In a borrowing scenario, maturity is when a note or a bill would

otherwise become due

6. Accumulated Value - the total dollar amount of all payments,

including interest, by the end of an annuity term
5. Hurdle Rate - The minimum rate of return on a project or investment
required by a manager or investor

3 & 4: Author: Sam Irlander; 5 & 6 Source: Investopedia.com

TIME VALUE OF MONEY: ASSUMPTIONS

Assumptions about TVM (from David R. Frick & Co., CPA)
Money is always invested and always productive so that
returns can be reinvested at a rate equal to r
The yield curve is flat so that short term interest rates are
equivalent to long term interest rates
Time periods are all of equal length
Payments are all equal, and either all inflows or all outflows
The interest rate is constant throughout the term
Annuities are simple, certain, discrete and ordinary
For more about TVM, see: www.frickcpa.com/tvom/default.asp

Source: http://www.frickcpa.com/tvom/TVOM_Assumptions.asp

TIME VALUE OF MONEY:

SIX FUNCTIONS OF A DOLLAR
1.

Future Value: What will the value of a dollar grow to in n periods at r

interest?

2.

Present Value: What is the value today of a dollar received n periods in the
future if one's opportunity cost is r?

3.

Future Value of an Annuity: What will a dollar set aside at the end of each
year accumulate to after n periods at r interest?

4.

Present Value of an Annuity: What is the value of the right to receive a

dollar each of the next n periods if opportunity cost is r?

5.

Sinking Fund Factor: How much must be set aside in each of n periods at
r interest in order to reach a specific sum in the future?

6.

Debt Amortization: What payment is required to amortize a debt of one

dollar over n periods at r interest?

TVM: FUTURE VALUE (1)

What will the value of a dollar grow
to in n periods at r interest?
= 1 +

r = 10%; N = 2
FV = $1.00 1.10

Application:
Future value calculations
can be used to show the
amount of money todays
energy savings will grow to
in a specific number of
years.

FV = $1.21

Excel: = , , ,
= (.10,2,0,1)

Formula Source: http://owll.massey.ac.nz/maths-and-statistics/finance-formulas.php

TVM: PRESENT VALUE (2)

What is the value today of a dollar
received n periods in the future if
the cost is r?
1
=
1+
= 10%; = 2

= $1.00

Application:
Present value calculations can
be used to show todays value of
your future energy savings.

1
1.10

= $0.83
Excel: = , , ,

Formula Source: http://owll.massey.ac.nz/maths-and-statistics/finance-formulas.php

TVM: FUTURE VALUE OF AN ANNUITY (3)

What will a dollar set aside at the
end of each year accumulate to after
n periods at r interest?

Application:

(1 + ) 1
=

Future value of an annuity

calculations can be used to
show the amount of money
your energy savings over a
specific time frame will be
worth at a future date.

1 + 0.10 2 1
= 1
0.10
= $2.10

Excel: = , , ,

Formula Source: http://owll.massey.ac.nz/maths-and-statistics/finance-formulas.php

TVM: PRESENT VALUE OF AN ANNUITY (4)

What is the value of the right to
receive a dollar each of the next n
periods if opportunity cost is r?
(1 + ) 1
=
(1 + )

Application:
Present value of an annuity
calculations can be used to
show the amount of money
your energy savings over a
specific time frame in the
future is worth today.

$1.00 2 ;
= 10%
= $1.74
Excel: = , , ,

Formula Source: http://owll.massey.ac.nz/maths-and-statistics/finance-formulas.php

TVM: SINKING FUND FACTOR PAYMENT (5)

How much must be set aside in each
of n periods at r interest in order to
reach a specific sum in the future?

(1 + ) 1

= 1

0.1
1 + 0.1 2 1

Application:
Sinking Fund Factor Payment
calculations can be used to
show the amount of money
you would need to set aside
each year in order to achieve
a certain target value at a
future date.

= $0.48
Excel: = (, , 0, 1.00)
Formula Source: http://owll.massey.ac.nz/maths-and-statistics/finance-formulas.php

TVM: DEBT AMORTIZATION PAYMENT (6)

What payment is required to
amortize a debt of one dollar over n
periods at r interest?

(1 + )
=
(1 + ) 1

= $1.00

0.1 1 + 0.1 2
1 + 0.1 2 1

Application:
Debt Amortization Payment
calculations can be used to
show the amount of money
you would pay each year in
order to completely amortize
the amount of debt used to
fund energy efficiency
upgrades.

= $0.58
Excel: = (, , 1,0)
Formula Source: http://owll.massey.ac.nz/maths-and-statistics/finance-formulas.php

HOW TO CALCULATE PROJECT CASH FLOWS

Use or create an Excel model to calculate cash flows.
Apply the terms and associated costs.

Year

Acquisition Cost
Utilization Cost
Energy Savings
Net Annual Savings
Residual Value

(2,000,000)

Cash Flows

(2,000,000) 400,000

10

(100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000)
500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000
400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000
50,000
400,000

400,000

400,000

400,000

400,000

400,000

400,000

Note: This cash flow does not include the time value of money.

400,000

450,000

WHAT IS NET PRESENT VALUE (NPV)?

Net Present Value (NPV) is the difference between the present
value of cash inflows and the present value of cash outflows.
NPV is used in capital budgeting to analyze the profitability of an
investment or project.

NPV analysis is sensitive to the reliability of projections about

future cash inflows that an investment or project will yield.
NPV formula:

=
=1

(1 + )

Source: http://www.investopedia.com/terms/n/npv.asp#axzz2BkUNo2EJ

THE NPV DECISION RULE

The Net Present Value (NPV) of a project is based on the projects
expected impact on the value of the company.
Projects with a positive NPV are expected to increase that value
Projects with a negative NPV are expected to decrease that value
The NPV Decision Rule states, in short, that:
A project with a positive NPV should be accepted
A project with a negative NPV should be rejected; and
Among mutually exclusive projects, the project with the greatest
positive NPV should be chosen.

CALCULATING NPV:
STANDARD DISCOUNT RATE

In Excel: =NPV(r, cash flows)

In this example the discount rate is 9%

(This is the approximate risk-cost of capital in 2012)

By applying a discount rate of 9%, the NPV is positive

Therefore, you would pursue the project

Year

Acquisition Cost
Utilization Cost
Energy Savings
Net Annual Savings
Residual Value

0
(2,000,000)

10

(100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000)
500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000
400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000
50,000

Cash Flows

(2,000,000) 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 450,000

r
NPV

9%
539,618.00

CALCULATING NPV:
ENERGY SAVINGS DISCOUNT RATE

In Excel: = NPV(r, cash flows)

In this example the discount rate is 8%

Green projects merit a lower discount rate than standard projects

because of the long-term value that they add.

By applying the energy savings discount rate of 8%, the NPV is a

greater positive value than the 9% standard discount rate

Therefore, you would pursue this higher NPV project

Year

Acquisition Cost
Utilization Cost
Energy Savings
Net Annual Savings
Residual Value
Cash Flows

0
(2,000,000)

10

(100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000)
500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000
400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000
50,000
(2,000,000) 400,000

r(e)
NPV
9% Discount Rate NPV

8%
$654,807.62
$539,618.00

Change in NPV
% Change in NPV

$115,189.62
21.35%

400,000

400,000

400,000

400,000

400,000

400,000

400,000

400,000

450,000

CALCULATING NPV: EXAMPLES

Year
Acquisition Cost
Utilization Cost
Energy Savings
Net Annual Savings
Residual Value

0
(2,000,000)

(2,000,000) 400,000

r
NPV

9%
539,618.00
Year

Acquisition Cost
Utilization Cost
Energy Savings
Net Annual Savings
Residual Value

0
(2,000,000)

(2,000,000) 400,000

r
NPV

10

400,000

400,000

400,000

400,000

400,000

400,000

400,000

400,000

450,000

10

400,000

400,000

400,000

400,000

400,000

400,000

400,000

400,000

450,000

10

15%
0.00
Year

r
NPV

(100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000)
500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000
400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000
50,000

Cash Flows

Cash Flows

(100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000)
500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000
400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000
50,000

Cash Flows

Acquisition Cost
Utilization Cost
Energy Savings
Net Annual Savings
Residual Value

0
(2,000,000)

(100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000)
500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000
400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000
50,000
(2,000,000) 400,000
22%
(328,050.53)

400,000

400,000

400,000

400,000

400,000

400,000

400,000

400,000

450,000

WHAT IS THE INTERNAL RATE OF RETURN?

Internal Rate of Return (IRR) is a commonly-used concept in project and

investment analysis.
The IRR of a project or investment is the discount rate that results in an NPV
of zero.
If the companys actual cost of capital (discount rate) is lower than the IRR,
the project or investment should be undertaken.
Accept the project if the IRR > Hurdle Rate.
In Excel, IRR function: =IRR(cash flows)
Year

Acquisition Cost
Utilization Cost
Energy Savings
Net Annual Savings
Residual Value
Cash Flows
IRR

0
(2,000,000)

10

(100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000)
500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000
400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000
50,000
(2,000,000) 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 450,000
15.3%

Source: http://www.environment.ucla.edu/media_IOE/files/Retrofitting-Commercial-Real-Estate-30-mlg.pdf

INTRODUCTION OF THE ENERGY DELTA

WEEK 2: IN-CLASS EXERCISES

In the Module, locate the Excel file containing embedded formulas for
the functions of a dollar. The file also includes a cash-flow table for a
new energy-saving hot water project. Experiment with different
scenarios by altering your acquisition costs and tax incentives.
Observe how your variations impact Cash Flow, Net Present Value
(NPV), and Internal Rate of Return (IRR).
Write up a brief description of your observations. Discuss how changes
in tax rates can impact the value of new investments in energy-efficient
technology. How else may incentives be created, eliminated, or shifted?
Besides raising rents, how might building owners get tenants to share
in the costs of acquiring energy-saving improvements?

WEEK 2: HOMEWORK
1.

Describe the NPV decision rule, and explain the rationale behind it.
How is the rule used by real estate owners and managers to
choose between competing proposals for their portfolios?

2.

Explain the rationale that underpins the Time Value of Money

concepts that were discussed in class. What is the basic
assumption that underpins TVM analysis? Provide two or three
examples of situations in which specific TVM principles would
play an important role in the financial analysis of an investment.