Testbank

to accompany

nd
Financial Planning 2
edition
By
Warren Mckeown, Mike Kerry, Marc Olynyk

Prepared by

Peter Lennox
University of South Australia

© John Wiley & Sons Australia, Ltd 2014

Testbank to accompany Financial Planning 2nd edition

Chapter 6
Direct investment - property

Multiple-choice questions

1. A characteristic of property is:

a. it is generally regarded as an intangible form of investment.

*b. it is generally regarded as an illiquid form of investment.
c. returns may comprise income but not capital.
d. entry costs and exit costs can be relatively low.

Correct answer: b
Feedback: An investment in property is generally regarded as an illiquid form of investment
as it is difficult to realise within a short period of time. Learning objective 6.1 ~ outline the
qualities and characteristics of property for investment.

2. An example of direct property investment is:

a. John is a registered investor in a listed real estate investment trust.

b. Jill holds units in an unlisted property trust.
*c. James is the registered owner of a commercial property.
d. Jenny is a member of a private property syndicate.

Correct answer: c
Feedback: James holds a direct property investment as the registered owner of a commercial
property. All the others are examples of an indirect investment in property. Learning
objective 6.2 ~ describe the different forms of property investment.

3. Increases in capital city house prices may be the result of:

*a. the policy of state governments to limit the supply of land by means of zoning.
b. lower levels of immigration.
c. the threat of a higher taxation policy on property investment.
d. a decrease in office jobs in city areas.

Correct answer: a
Feedback: Increases in capital city house prices may be the result of state governments
limiting the supply of land around capital cities by means of zoning (which means that tracts
of land are not available for housing development). Learning objective 6.2 ~ describe the
different forms of property investment.

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 Chapter 6: Direct Investment - property

4. Characteristics of an A-REIT include:

a. units being issued to investors on establishment.

b. prices fluctuating in accordance with general market sentiment on the ASX.
c. investors receiving distributions in the form of fully-franked dividends.
*d. both a and b.

Correct answer: d
Feedback: As a security listed on the ASX, characteristics of an A-REIT include prices
fluctuating in accordance with general market sentiment on the ASX and investors being
issued units as evidence of their investment. Learning objective 6.3 ~ describe the features
and benefits of property funds.

5. As compared to an A-REIT, an unlisted property trust is likely to:

a. be smaller in size holding less properties.

b. have relatively more debt as a proportion of the total trust assets.
*c. both a and b.
d. none of the above.

Correct answer: c
Feedback: As compared to an A-REIT, an unlisted property trust is likely to be smaller in
size holding less properties and have relatively more debt as a proportion of the total trust
assets. Learning objective 6.3 ~ describe the features and benefits of property funds.

6. The NTA of an unlisted property trust assuming all other items are held constant:

a. will increase in situations where the fund manager decides to repay

principal on outstanding debt from surplus cash holdings.
b. will increase in situations where the fund manager decides to revalue
upwards the amount included in the balance sheet for goodwill attached to a
prominent property held by the fund.
*c. is used by fund managers to determine the current value of units in the trust
before adjusting for any management fees.
d. both a and c.

Correct answer: c
Feedback: The net tangible assets (NTA) of an unlisted property trust assuming all other
items are held constant is used by fund managers to determine the current value of units in
the trust before adjusting for any management fees. The repayment of principal or the
revaluation of an intangible asset such as goodwill will not affect the NTA of the trust.
Learning objective 6.3 ~ describe the features and benefits of property funds.

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Testbank to accompany Financial Planning 2nd edition

7. Mortgage funds:

a. provide opportunities for capital growth returns for investors.

b. will increase their loan-to-value ratio the relatively higher the risk of the
borrower.
*c. are a relatively illiquid investment at least in the early periods after issue.
d. both a and b.

Correct answer: c
Feedback: Given that many mortgage funds require a 12-month period of investment before
allowing for redemption they would be considered to be a relatively illiquid investment.
Learning objective 6.3 ~ describe the features and benefits of property funds.

8. The income to be declared in the income tax return which relates to property
investment consists of the gross rental income from the tenant. The deductions that can
offset the income include:

*a. interest on the loan taken out to purchase the property.

b. a portion of the set-up costs of borrowing the funds which are allowed to be
deducted over a 3-year period.
c. a capital depreciation allowance of 4.0% of the cost of the building is allowable
for 40 years.
d. a capital expense such as the addition of an air conditioner to the property.

Correct answer: a
Feedback: Most property owners borrow money to acquire an investment property and under
taxation rules, are allowed to deduct the interest component as a cost of earning the income.
Borrowing costs are deductible over a 5-year period and a depreciation allowance of 2.5% of
the cost of the building is allowable for a 40-year period. Capital expenses are not available
directly as an allowable deduction. Learning objective 6.4 ~ explain the taxation effects of
investing in property.

9. Property trusts:

a. are taxpaying entities.

*b. can make tax-deferred distributions to individual unitholders who benefit
differentially on an after-tax basis depending on their personal marginal tax rate.
c. can withhold income distributions to unitholders in any year depending on the
trusts expected cash flow requirements for the following period.
d. both b and c.

Correct answer: b
Feedback: Property trusts can make tax-deferred distributions to individual unitholders who
benefit differentially on an after-tax basis depending on their personal marginal tax rate. They
are not taxpaying entities and must make income distributions at least once per year.
Learning objective 6.4 ~ explain the taxation effects of investing in property.

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 Chapter 6: Direct Investment - property

10. Tax-deferred distributions from property trusts:

a. are declared by the unitholder recipient as income in the tax return in the year of
receipt.
*b. are used by the unitholder recipient to decrease the cost base of the investment in
the property trust.
c. are used by the unitholder recipient to increase the cost base of the investment in
the property trust.
d. are only available to unitholder recipients where they have held their investment
in the property trust for at least 12 months.

Correct answer: b
Feedback: Tax-deferred distributions from property trusts are used by the unitholder recipient
to decrease the cost base of the investment in the property trust thus increasing the potential
capital gain on realisation of their investment. Learning objective 6.4 ~ explain the taxation
effects of investing in property.

11. A tax-free component and a tax-deferred component are two taxation benefits
associated with the income derived by a property. The tax-deferred component:

a. derives from building depreciation allowances and provides for tax relief for a
period of five years.
b. derives from depreciation of furniture and fittings and provides tax relief for a
period of seven years.
*c. derives from building depreciation allowances and the accumulated sum reduces
the cost base of the property when it is sold.
d. derives from depreciation of furniture and fittings and the accumulated sum
adds to the cost base of the property when it is sold.

Correct answer: c
Feedback: The tax-deferred component derives from building depreciation allowances and
the accumulated sum reduces the cost base of the property when it is sold. Learning objective
6.4 ~ explain the taxation effects of investing in property.

12. Alice sells a property in 2014 for $300,000 that she has held for five years. She bought
the property for $200,000 and during the period of ownership she claimed a building
depreciation allowance of $8,000 each year. Given a marginal tax rate of 46.5%
(including the Medicare levy) the relevant tax to be paid relating to the sale will be:

*a. $32,550
b. $65,100
c. $27,900
d. $46,500

Correct answer: a
Feedback: The tax on the capital gain paid by Alice is $32,550.
Sale proceeds $300,000
Purchase price $200,000

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Testbank to accompany Financial Planning 2nd edition

Less tax-deferred amounts

$8,000 x 5 ($40,000)
Reduced cost base $160,000 ($200,000 - $40,000)
Capital gain for tax $140,000 ($300,000 - $160,000)
Discounted capital gain (50%) $70,000
Tax on capital gain @ 46.5% = $32,550
Learning objective 6.4 ~ explain the taxation effects of investing in property.

13. What is the valuation approach which is described as follows: “An estimated market
value made by comparing recent sales figures to provide a return required by investors
based on the income stream paid to investors less normal operating expenses”?

a. The cost approach.

b. The direct comparison approach.
c. The securitisation approach.
*d. The capitalisation approach.

Correct answer: d
Feedback: The capitalisation approach is an estimated market value made by comparing
recent sales figures to provide a rate of return currently required by investors based on the
income stream paid to investors (i.e. the rent charged to tenants) less normal operating
expenses. A rate of return is then applied to determine a market value. Learning objective 6.5
~ apply valuation methods to an investment in property.

14. The capitalisation approach results in:

a. a higher market value the greater the capitalisation rate used for a given net rental
income stream.
*b. a lower market value the greater the capitalisation rate used for a given net rental
income stream.
c. a lower market value the lower the capitalisation rate used for an increasing net
rental income stream.
d. both a and c.

Correct answer: b
Feedback: Given the nature of the underlying formula used, the capitalisation approach
results in a lower market value the greater the capitalisation rate used for a given net rental
income stream. Learning objective 6.5 ~ apply valuation methods to an investment in
property.

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 Chapter 6: Direct Investment - property

15. Establishing a market value for older buildings is more problematic using the:

*a. cost approach.

b. direct comparison approach.
c. capitalisation approach.
d. both a and b.

Correct answer: a
Feedback: Establishing a market value for older buildings is more problematic using the cost
approach as it is difficult to place a value on the uniqueness of some older buildings,
including such considerations as their heritage value. Learning objective 6.5 ~ apply
valuation methods to an investment in property.

16. The Net Present Value (NPV) approach:

*a. is a suitable form of analysis for property investments.

b. would include net rental income as cash outflows as part of NPV analysis.
c. results in a greater positive NPV / lower negative NPV when a relatively higher
discount rate is used.
d. both b and c.

Correct answer: a
Feedback: The Net Present Value (NPV) approach is a suitable form of analysis for property
investments. This approach would include net rental income as cash inflows and results in a
lower positive NPV / greater negative NPV when a relatively higher discount rate is used.
Learning objective 6.5 ~ apply valuation methods to an investment in property.

17. When providing advice to a client on whether it is best for them to rent or buy a family
home based only on financial grounds, the advice:

a. will favour the buying option in times of relatively low interest rates and current
flat housing prices.
b. will favour the buying option in times of relatively tight rental markets.
*c. both a and b.
d. none of the above.

Correct answer: c
Feedback: It is likely that advice would favour buying in times of relatively low interest rates
and current flat housing prices and in times of relatively tight rental markets. In these times
the purchase value of property is likely to be relatively lower, borrowing more accessible and
the alternative (renting) relatively more costly. Learning objective 6.7 ~ discuss financial
implications of home ownership versus renting.

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Testbank to accompany Financial Planning 2nd edition

18. Which of the following statements regarding loan types is incorrect?

a. Capped loans provide some certainty to the borrower regarding interest rates for a
specified period before they revert to standard variable loans.
*b. Equity loans require the borrower to undergo an approval process each time they
wish to borrow from this facility.
c. 100% offset loans benefit from potentially decreasing interest expenses for the
borrower if used wisely.
d. None of the above.

Correct answer: b
Feedback: Equity loans are attractive to some borrowers because they do not require the
borrower to undergo an approval process each time they wish to borrow from this facility.
Learning objective 6.7 ~ discuss financial implications of home ownership versus renting.

19. A person’s equity in their own home valued 10-years after initial purchase:

a. is the difference between the current market value of the home and their initial
purchase price.
b. is the difference between the current market value of the home and the amount
initially borrowed on a principal and interest home loan.
*c. will rise with principal loan repayments on borrowings assuming housing prices
at least remain constant.
d. will decrease with principal loan repayments on borrowings assuming housing
prices at least remain constant.

Correct answer: c
Feedback: A person’s equity in their own home will rise with principal loan repayments on
borrowings assuming housing prices at least remain constant. Learning objective 6.7 ~
discuss financial implications of home ownership versus renting.

20. Where a single homeowner dies in 2014 and bequests their family home which was
originally purchased in 2001 to a beneficiary:

a. the home will be subject to a potential capital gains tax liability if sold by the
beneficiary within 1 year following the death of the homeowner using the original
purchase price as the cost base.
*b. the home will be exempted from a potential capital gains tax liability if sold by
the beneficiary within 2 years following the death of the homeowner.
c. the home will be valued at its market value at the date of death of the homeowner
and subject to sale on any subsequent disposal by the beneficiary.
d. none of the above.

Correct answer: b
Feedback: In these circumstances given the home was the family home of the deceased, sale
by the beneficiary within 2 years following the death of the homeowner will be exempt from
the CGT. After 2 years following the death of the homeowner, a sale would be subject to a
potential capital gains tax liability with the original purchase price used as the cost base of the

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 Chapter 6: Direct Investment - property

home given its original purchase after the introduction of the CGT (acquired in 2001).
Learning objective 6.9 ~ understand the taxation implications of home ownership.

© John Wiley and Sons Australia, Ltd 2014 6.9

Testbank to accompany Financial Planning 2nd edition

Short Answer Questions

21. Outline six of the positive characteristics that are associated with an investment in
the property market.

Answer: Your answer could include any six of the positive characteristics that follow below:
- It is generally regarded as a solid, tangible form of investment — some investors argue that
they are investing in ‘bricks and mortar’ rather than a piece of paper representing a share
certificate,
- Land is a scarce commodity and subject to changes in value according to demand – with
demand typically increasing over time,
- Returns are less volatile than dividends paid from shares and capital values are relatively
stable compared to shares,
- Returns may comprise both capital and income,
- A higher level of gearing is possible as lenders prefer to lend against property investments.
- Taxation advantages, such as depreciation allowances, provide investment incentives.
- Some property investments can offer diversification across a range of property classes as
well as diversification of asset portfolios,
- Property market values are not subjected to daily valuations, unlike the share market, and
- Property markets exhibit pronounced cycles which do not necessarily coincide with other
asset classes thus providing diversification benefits.

Learning objective 6.1 ~ outline the qualities and characteristics of property for investment.

22. Discuss the range of factors that you would consider when considering the
purchase of a commercial property.

Answer: Commercial property requires a larger sum of money for investment than a
residential property as the price can range from around $200 000 to $20 million or even much
more. The purchase of a commercial property also requires the choice of the type of
commercial property to invest in. It includes a wide range of real estate (CBD, suburban
strips, regional centres) such as office, retail, industrial factory, warehouse, farming,
infrastructure or leisure and tourism properties. Each type of property has different risk and
return characteristics together with different income and capital growth features.

There are several factors to consider in buying a commercial property, such as the local
geographic area, the trend in consumer demand and labour supply, lease covenants, zoning
restrictions, redevelopment potential and specific information relating to the property itself
(such as the amount of rent, terms of leases, vacancy levels and expected yields). In addition,
the purchaser needs to have a comparative basis for the value of the property or some other
means to ensure the property is purchased at a fair value.

Learning objective 6.2 ~ describe the different forms of property investment.

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 Chapter 6: Direct Investment - property

23. Imagine you are having a discussion with a friend about investment in property.
Your friend favours a direct form of investment because of the costs involved with
a property fund but would like to know the benefits of investing in a property
fund. Provide an outline of these benefits.

Answer: Property funds provide the opportunity to invest in a number of properties, allowing
investors to diversify their portfolio by location, size and sector (for example, office,
industrial, shops, hotels) for a relatively small initial outlay. They are a ‘unitised’ investment,
allowing the buyer to purchase a parcel of units representing a pro-rata entitlement to the
distribution of income which is derived generally from rent from the trust’s properties. This
also provides a benefit in terms of selling the investment as unlike direct property, partial
sales can be undertaken. This provides a significant degree of flexibility and reduces the
pressure on the investor to have to time the market for both entry and exit as is the case with
direct property investment.

In addition, property funds do not require management by the unit holder because the
ongoing maintenance and management of the trust is undertaken by the Responsible Entity
(manager). The only decisions required by the investor are the buy or sell decision and those
related to voting at general meetings. Hence investors that are time-poor are likely to be
attracted to this form of property ownership.

Learning objective 6.3 ~ describe the features and benefits of property funds.

24. a) Given the following information, calculate the net tangible asset (NTA) price
per unit of the “Futuristic Office Property Fund” which is an A-REIT.

Market value of property held by the fund is $80,000,000; the mortgage owed to
lenders is $50,000,000; and the number of units issued to the public is 20,000,000.

b) The market price of the fund is currently trading at a discount of 10% to the
answer derived in part a) of this question. Calculate this market price and discuss
why a price different to the NTA may occur for an A-REIT.

Answer:
a) Market value of property held by the fund $80,000,000
Less: mortgage debt owed to lenders $50,000,000
Equals net asset value $30,000,000
Divided by number of issued units 20,000,000
Equals price per unit (NTA) $1.50

b) As the NTA is $1.50 and the price is currently trading at a 10% discount the adjusted price
will be $1.35 calculated as:
$1.50 x (1 – 10%)
= 0.9 x $1.50
= $1.35
Because properties are not revalued on a daily basis, units of A-REITs may trade at a
premium or discount to the net asset value of the fund depending on the market’s assessment
of the property trust’s prospects. In practice, the net asset value used is the net tangible asset
(NTA) backing of the fund. The NTA is derived from the net asset value by deducting

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Testbank to accompany Financial Planning 2nd edition

intangible assets, such as goodwill, brand names, copyright, etc. Factors relevant to the
market’s assessment of current unit prices may include: the income yield expressed as a
percentage of the property’s current market value relative to some benchmark such as current
interest rates; expected rental growth and capital growth which largely depends on the quality
of the underlying properties and the strength of the REIT’s management team; and general
economic conditions in Australia and the rest of the world.

Learning objective 6.3 ~ describe the features and benefits of property funds.

25. Outline the taxation advantages of investing in a property trust.

Answer: Property investors benefit from the discount (50% for individuals and 33.33% for
superannuation funds) available on capital gains and they also benefit through the
depreciation allowance rules to reduce assessable income. Thus, these are two specific
taxation advantages of investing in property in comparison to some of the other asset classes.
It should be noted that property funds are in the legal form of trusts. Trusts provide a ‘flow
through’ of the income and capital gain derived by the trust, and provide tax benefits in the
form of tax-free and tax-deferred income. Therefore, they are very tax effective for investors.
In many situations, the purchase of investment property (either directly or via a property
trust) is part of a negative gearing strategy (involving the use of borrowed funds) where the
total expenses from the investment will exceed the income. However, the ATO allows for the
loss on income to be claimed because in the long run, when the investment property is sold,
tax will be levied on the (expected) realised capital gain. Because trusts are not taxpaying
entities, they pass on the tax benefits to the unit holder which gives rise to a ‘tax advantaged’
component to distributions received by the investor. The tax-free component relates to certain
deductions available to the trust and the tax-deferred element derives from building
depreciation allowances. The value of this tax-advantaged component compared with the
distribution actually paid can be quite significant, particularly for investors in high tax
brackets. Of course deriving capital gains also provides the investor with the opportunity to
time the realisation of their investment (and thus their exposure to the CGT) which is not
available for income returns.

Learning objective 6.4 ~ explain the taxation effects of investing in property.

26. At the start of the current financial year Paul decided to purchase a newly
constructed apartment in the city for $400,000 which he hopes will increase his long-
term wealth and create some tax deductions given that he is on a 46.5% marginal tax
rate. He used $80,000 of his own money as a deposit and borrowed the remaining
$320,000 from Fast Finance on an interest-only loan for 5 years at a fixed interest rate
of 7% p.a.. Some additional details regarding the property purchase are listed below:
Purchase price of $400,000 consisting of $375,000 for the building costs and
$25,000 for depreciable plant and equipment. A building allowance of 2.5% p.a. and
plant and equipment depreciation of 20% p.a. is available for the purchase on a
straight-line basis. Property rental of 6% p.a. gross (of the total purchase cost) with
annual cash-based operating expenses (excluding financing) of $10,000.
a) Paul asks you to prepare a table to show how the income from the apartment would
be taxed and how it would affect his after-tax cash flow. Use the information

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 Chapter 6: Direct Investment - property

provided to complete the pro-forma table below for the first year after the property
purchase.

Cash flow Details $

Gross rent
Less property expenses paid in cash
Less interest payments
Net cash outflow before tax (A)

Less depreciation of building

Less depreciation of furniture, fittings, etc.
Taxable income
Tax loss (i.e. tax savings) (B)
After-tax cash flow (B-A)

b) Paul decides to sell the property after 5 years when the sale price is $600,000 and
selling costs are $20,000. Note that the value of plant and equipment originally
purchased for $25,000 at the time of sale is expected to be $nil. Your task is to
produce for Paul a schedule showing the taxation liability and the after-tax
proceeds on the sale of the property at this time. Use the table below for this task.

Net sale proceeds before tax $

Sale proceeds
Less selling costs
Net sale proceeds
Less repayment of interest-only loan
Net proceeds before tax (A)
Tax liability:
Net sale proceeds
Less purchase price
Less accumulated building depreciation
Reduced cost base
Capital gain
(net sale proceeds less reduced cost base)
Taxable gain
Tax on capital gain (B)
After-tax proceeds on sale of property (A – B)

Answer:
a) Cash flow $
Gross rent $400,000 @ 6% = 24,000
Less property expenses paid in cash (10,000)
Less interest payments (22,400)
Net cash outflow before tax (A) (8,400)
Less depreciation of building $375 000 @ 2.5% (9,375)
Less depreciation of furniture, fittings etc. $25 000 @ 20% (5,000)
Taxable income (22,775)
Tax loss (i.e. tax savings) assuming 46.5% tax rate (B) 10,590
After-tax cash flow (B-A) $2,190

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Testbank to accompany Financial Planning 2nd edition

b) Net sale proceeds before tax $

Sale proceeds 600,000
Less selling costs (20,000)
Net sale proceeds 580,000
Less repayment of interest-only loan (320,000)
Net proceeds before tax (A) 260,000
Tax liability:
Net sale proceeds 580,000
Less purchase price (375,000)
Less accumulated building depreciation (5 x $9,375) (46,875)
Reduced cost base (328,125)
Capital gain (net sale proceeds less reduced cost base) 251,875
Taxable gain (capital gain less 50% discount) 125,937
Tax on capital gain (46.5% tax rate) (B)58,560
After-tax proceeds on sale of property (A – B) $201,440

Learning objective 6.4 ~ explain the taxation effects of investing in property.

27. a) Use the capitalisation approach for the following situation to determine a
market value for a residential investment property that is planned to be rented for
a net amount of $20,000 p.a..

There have been three recent sales of rental properties recorded in a similar
location, as follows:

Similar property Annual rent Sale price Rate of return

(capitalisation rate)
62 Gray Street $22,000 $280,000 7.86%
150 White Avenue $19,000 $255,000 7.45%
33 Black Road $21,000 $270,000 7.78%

b) The capitalisation method can also be used to determine the net rent income that
can be demanded from a tenant. Suppose a person paid $290,000 for a rental
property in a similar area and required a net rental return (after annual operating
expenses of $11,000) of 9.0% p.a. from the investment. What would be the gross
rental income that could be expected?

Answer:
a) The capitalisation approach is an estimated market value made by comparing recent sales
figures to provide a rate of return currently required by investors based on the income stream
paid to investors (i.e. the rent charged to tenants) less normal operating expenses. The market
value can then be estimated by the following formula:
Market value = Annual net income
Rate of return (market capitalisation rate)

Using the information in the table, the capitalisation rate on average is 7.7% ([7.86% + 7.45%
+ 7.78%] / 3). So, if the net rental income from the property is projected to be $20,000, then
the market value would be calculated thus:

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 Chapter 6: Direct Investment - property

Market value = $20,000 / 7.7%:

= $259,740
b) The net rental income that could be expected is:
= $290,000 x 0.09 = $26,100
Hence the gross rental income after operating expenses of $11,000 will be:
= $26,100 + $11,000
= $37,100
Learning objective 6.5 ~ apply valuation methods to an investment in property.

28. Debra is assessing an investment in one of two residential rental properties under
consideration for a 3-year time frame.
Each property requires an initial outlay of $200,000 and would be sold at the end
of 3 years. Debra expects that at this time she could sell property A for $300,000
and property B for $280,000. She also anticipates an increase in net rental income
each year for each property. Property B is older but because of its excellent
location she expects to achieve a higher net rental even though its expected sales
price is likely to be a bit lower than property B.
If Debra did not want to invest in either of the two properties then she would
invest the $200,000 in a managed fund of equivalent risk which is expected to pay
a rate of return of 7% p.a.
The expected net income flows for both properties is shown below:
Year 1 Year 2 Year 3
Property A $10,000 $10,250 $10,500
Property B $11,000 $11,500 $12,000

a) Calculate the Net Present Value (NPV) of each of the two properties to assist
Debra with her decision.
b) Based on the NPV analysis which property, if any, should Debra buy?
c) Indicate the assumptions on which NPV is based that may, in fact, even lead
Debra to an investment decision that may be incorrect.

Answer:
a) NPV Property A =
-$200 000 + ($10,000 / [1 + 7%]1) + ($10,250 / [1 + 7%]2) + ($10,500 / [1 + 7%]3) +
($300,000 / [1 + 7%]3)
-$200 000 + ($10,000 x 0.9346) + ($10,250 x 0.8734) + ($10,500 x 0.8163) + ($300,000 x
0.8163)
= ($200,000) + $9,346 + $ 8,952.40 + $8,571.20 + $244,890
=$71,759.60
NPV Property B =
-$200 000 + ($11,000 / [1 + 7%]1) + ($11,500 / [1 + 7%]2) + ($12,000 / [1 + 7%]3) +
($280,000 / [1 + 7%]3)
-$200 000 + ($11,000 x 0.9346) + ($11,500 x 0.8734) + ($12,000 x 0.8163) + ($280,000 x
0.8163) = ($200,000) + $10,280.60 + $10,044.10 + $9,795.60 + $244,890
=$58,684.30

b) This analysis using the net present value (NPV) method tells Debra that it would be better
to invest in Property A (NPV of $71,760) rather than Property B (NPV of $58,684), as not
only is the NPV positive it is expected to return a higher NPV than Property B. If the NPV

© John Wiley and Sons Australia, Ltd 2014 6.15

Testbank to accompany Financial Planning 2nd edition

for both properties was negative, which may occur if the sale price after 3-years was
estimated to be a much lower figure, or the discount rate used was higher, then the investment
proposal may be abandoned and Debra would then be recommended to invest in the managed
fund.

c) This analysis assumes a known projection of income, a future sale price and a stable rate of
return for each alternative investment. However, it does provide a means of evaluating an
investment proposal despite its assumptions. By substituting other figures for expected sales
prices, income projections and a rate of return this method can provide a means of
considering the value of prospective investments under different scenarios. In practice, given
that rarely are any decisions are made in a totally certain environment, the NPV method can
be justified as a valid form of financial analysis.
Learning objective 6.5 ~ apply valuation methods to an investment in property.

29. Speculate on the reasons why, although the percentage of Australians occupying
their own home is very high by world standards, the proportion of the younger
population in Australia (those under 35 years of age) has been decreasing in more
recent times.

Answer:
The percentage of Australians occupying their own home has remained at about 70% for a
number of decades which is very high by world standards. For those under 35 however, the
percentage has decreased in more recent times to about 60%. Contributing factors for this
decline in Australia are likely to include any / all of the following:
- young people are remaining at home with their parents for longer – for example until after
they finish all their education which typically now includes tertiary / vocational study;
- people are getting married at a later age than previously (which is typically a trigger for
moving out of some and seeking to buy their own home);
- the casualisation of the workforce with many more people, particularly young people,
working on a casual / part-time / contractual relationship which provides for less certainty /
stability for both the person and the potential lender, making it less likely for them to seek /
obtain sufficient finance to purchase their own home; and
- increasing housing prices, particularly in urban areas, has made housing potentially less
affordable for those on lower incomes which is likely to include more younger people as they
seek to establish themselves in the workforce.

Learning objective 6.6 ~ identify advantages and disadvantages of home ownership.

© John Wiley and Sons Australia, Ltd 2014 6.16