102.

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1. The IRR, NPV, MIRR and DCF IRR Internal Rate of Return
stand for? NPV Net Present Value
MIRR Modified Internal Rate of Return
DCF Discounted cash flow

2. Which investment option would Answer. Option a) because the $300,000

you rather have and which option received today can be reinvested and will
is less risky? be worth more the $300,000 in five years
time
a) $300,000 today
b) $300,000 in five years time Option b) is also the less risky or safer
option.
Investment choices involve taking into
account the "Time Value of Money" and
the investment risk.

3. Which of the following are true? Answer. All these statements are true.
Discounted cash flow analysis Discounted cash flow takes into account:
considers the: 1) Time value of money 2) The impact of
1) Time value of money 2) The im- financial leverage
pact of financial leverage 3) Considers changing revenues and ex-
3) Changing revenues and ex- penses over time 4) Calculates the IRR
penses over time and NPV
4) Uses the IRR and NPV 5) Sale at the end of the Analysis Period
5) The sale at the end of the Analy- 6) The Cap Rate approach ignores all of
sis Period the above and uses the Net Operating
6) The above items are ignored Income (NOI) to value the property
when using the Cap Rate

4. In carrying out long term real The time period in years used to carryout
estate investment or discounted the analysis.
cash flow analysis the "Analysis
Period" refers to: It is the time in years from when the
investment is acquired until it is sold.

5. What is the recommended analy- a) Rental apartment buildings. Five years

sis period for: but maybe 10 years
a) Rental apartment buildings
b) Commercial buildings b) Commercial buildings. Because of the
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lease renewals it is probably wise to use
an "Analysis Period" of 10 years or more
in order to reflect the impact of lease
renewals and tenants moving out and the
costs associated with re-leasing space

6. The Cap Rate and Internal Rate of
Return (IRR) create the same es-
timate of value because they are
both a 'Return on Investment"
True or False?
False. The Cap Rate and the IRR likely
result in different estimates of value.
The Cap Rate is a very simple measure
using the Net Operating Income (NOI)
and the Cap Rate to establish the value.

The Internal Rate of Return (IRR) is a

more comprehensive approach that con-
siders the "Time Value of Money", chang-
ing cash flows, the impact of financial
leverage and the eventual sale of the
property

7. The Cap Rate approach is the ...

best method for valuing an in-
vestment that has the following
lease arrangement over the next
16 years.
Yr 1. $21 psf. per Yr
Yrs 2- 6 $23 psf. per Yr.
Yrs 7-11 $26 psf. per Yr
Yrs 12 -16 $29 per Sq. Ft per Yr.
TRUE or FALSE?

8. Can you use a standard mortgage

calculator to calculate the return
on investment (the interest rate)
for this cash flow
Year 0. <$600,000>
Year 1. 200,000
Year 2. 250,000
Year 3. 310,000

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9. Which statement is correct? a) If the Net Present Value (NPV) is pos-
itive the return is greater than the invest-
a) If the Net Present Value (NPV) ment's discount rate or desired return
is positive the return is greater
than the investment's discount
rate or desired return

b) If the Net Present Value (NPV)

is negative the return is greater
than the investor's discount rate
or desired return

10. If the Net Present Value (NPV) at Correct answer is b)

the Investor's discount rate or de- If the Net Present Value (NPV) at the In-
sired return is negative the return vestor's discount rate or desired return is
on investment (IRR) is negative the return on investment (IRR)
a) greater than is less than the Investor's desired return
b) less than or discount rate.
the Investor's desired return or
discount rate.

11. Which statement is correct? The c) The Investor's discount rate or desired
Investor's discount rate or de- return is used to calculate the Net Pre-
sired is used to calculate the: sent Value (NPV)

a) Cap Rate Example

b) Internal Rate of Return (IRR)
c) Net Present Value (NPV)
d) Cash on Cash or Return on Eq-
uity
e) None of these
Net Present Value (NPV) at 13% is
$235,000
Note. When quoting the NPV you need
to state the discount rate being used to
calculate the NPV

12. When carrying out real estate in- the RISK.

vestment analysis you look at
the financial "Reward" such as
the Internal Rate of Return (IRR)
and the Net Present Value (NPV)
AND......?
Always balance the Risk and the RE-
WARD.
The higher the risk the higher the desired
return on investment (IRR)

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13. If the investor's discount rate The price has to be reduced by $329,000
or desired return is 11% and
the Net Present Value (NPV) is The Internal Rate of Return (IRR) will
$<329,000> how much does the be 11% which is the investor's desired
purchase price have to be re- return.
duced to get the return of 11%?

14. Which items are not included

when calculating the yearly cash
flows from an investment in an
income property?

a. Potential Gross Income

b. Vacancy Loss
c. Operating Expenses
d. Principal Payments
e. Interest Payments
f. Future Sale Price
g. Cap Rate
h. Major capital expenditures

15. Which of the following financial
measures does not take into ac-
count the "Time Value of Mon-
ey"?
a) Debt Service Ratio
b) Cap Rate
c) Internal Rate of Return (IRR)
d) Return on Equity (Cash on
Cash)
e) Net Present Value (NPV)
f) Modified Internal Rate of Return
(MIRR)
The following calculations do not involve
the "Time Value of Money"
a) Debt Service Ratio
b) Cap Rate
d) Return on Equity (Cash on Cash)
These calculations use the "Time Value
of Money"
c) Internal Rate of Return (IRR)
e) Net Present Value (NPV)
f) Modified Internal Rate of Return
(MIRR)

16. If the Investor's "discount rate" 1) The return is higher than 13%
or "desired return on investment: 2) If the investor paid $283,000 more for
is 13% and the Net Present Value the property they would get a 13% return
(NPV) of a potential investment is (IRR)
$283,000 what does this tell you?

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17. What does the term "Capital Ex- A capital expenditure is a major, one off
penditure" mean? expenditure such as replacing the roof
or a major upgrade to the building or the
interior and generally depreciated for tax
purposes.

Capital expenditures are not treated as

an operating expense because they pro-
vide benefits greater than one year.

18. What does the 'Re-investment as- The re-investment assumption refers to
sumption" refer to when calcu- how positive and negative (losses) cash
lating the Internal Rate of Return flows are re-invested.
(IRR)?
If the Internal Rate of Return (IRR) is
14% the re-investment assumption used
when calculating the IRR assumes that
positive cash flows are re-invested at
14% and cost of funds borrowed to cover
losses is 14%.

19. If you received the following cash The Internal Rate of Return (IRR) is also
flow and calculated the Interest 9.70%. For an even cash flow the inter-
Rate the answer is 9.70% est rate and the Internal Rate of Return
Yr (IRR) are the same.
0 <400,000
1 160,000 However for uneven cash flows you have
2.160,000 to calculate the IRR and can't use a stan-
3.160,000 dard mortgage calculator.
What is the Internal Rate of Re-
turn (IRR)?

20. Can you calculate the return on Answer is no.

investment or interest rate for You cannot use a standard mortgage cal-
the following investment using a culator to calculate the interest rate or
standard mortgage calculator return on investment for an uneven cash
Yr flow. You have to use a financial calcula-
0 <730,000> tor or computer program that calculates
1 350,000 the Internal Rate of Return (IRR)

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2 400,000
3 150,000...unven cash flow

21. Which statement is correct? Answer a)

If the Net Present Value (NPV) is positive
a) If the Net Present Value (NPV) the return is greater than the Investor's
is positive the return is greater discount rate or desired return.
than the investment's discount
rate or desired return If the NPV is negative the return is less
than the Investor's discount rate or de-
b) If the Net Present Value (NPV) sired return on investment
is negative the return is greater
than the investor's discount rate
or desired return

22. The Investor's discount rate is c) The Net Present Value (NPV)
used to calculate the:

a) Cap Rate
b) Internal Rate of Return (IRR)
c) Net Present Value (NPV)
d) Cash on Cash or Return on Eq-
uity
e) None of these

23. Which one of the following might We like to use a discount rate that:
be a good reference point in de- a) Uses published data
ciding on the "Discount Rate" or c) where the investments have similar
"Desired Return" when calculat- risks and characteristics.
ing the Net Present Value (NPV)?
The choice is....
a) A conservative second mort- a) A conservative second mortgage rate
gage rate for the same kind of for the same kind of property
property
b) The Cap Rate from comparable
properties
c) Government bond rate
d) The average return for a large

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REIT (Real Estate Investment
Trust)

24. The analysis of an investment Answers

property shows the following re-
sults: a) The price has to be reduced by
Financial Returns (Before tax) $319,118 to get the desired return of
with financing 11%
b) If the price is reduced by $319,118 the
Internal Rate of Return (IRR): IRR will be 11% and the NPV will be zero
7.95%
Net Present Value (NPV) at 11%:
$<319,118>
a) How much does the price have
to be reduced to get the desired
return of 11%?
b) If the price is reduced by this
amount what is the IRR and the
Net Present Value at 11%?

25. The reinvestment assumption Answer is a)

used when calculating the Inter-
nal Rate of Return (IRR) If the Internal Rate of Return on an in-
vestment is 17% the reinvestment as-
a) Can cause the Internal Rate of sumptions assumes that positive cash
Return (IRR) to be overstated flows be reinvested at 17%.
b) Has no impact on the Internal
Rate of Return (IRR) Investing the positive cash flows on a
short term basis at 17% is highly unlikely.

This means that the IRR will overstate

the true return which will be less than the
IRR of 17%

26. If the Internal Rate of Return (IRR) Answer is c) 16.17%

is 16.17% when calculating the In- When calculating the IRR the reinvest-
ternal Rate of Return (IRR) losses ment assumption assumes losses are
are borrowed at: borrowed at the IRR which in this case
is 16.17%

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a) 0%
b) The interest rate used for the While this is not realistic it's the way the
first mortgage calculation of the IRR works
c) 16.17%
d) 15% This is another measure called the Mod-
ified Internal Rate of Return (MIRR)
which utilizes a short term reinvestment
and borrowing rate but is not widely used
compared to the IRR.

27. The Cap Rate and the Internal
Rate of Return (IRR) are similar
measures and therefore can be
compared.
True or False?
FALSE. The Cap Rate and Internal Rate
of Return (IRR) are very different finan-
cial measures or returns on investment
The Cap rate is a very simple measure
using the Net Operating Income, ignor-
ing changing cash flows over time, the
impact of financing and the eventual sale
of the property.

The IRR takes these factors into ac-

count.

Generally the IRR is higher than the Cap

Rate. As an example, why would you
invest at a Cap Rate of 4% and finance
at 6%? One reason is capital appreci-
ation which is ignored when calculating
the cap rate but taken into account when
calculating the IRR.

28. The Internal Rate of Return (IRR) Under normal circumstances the Internal
is generally "Higher" or "Lower" Rate of Return (IRR) is higher than the
than the Cap Rate? Cap Rate.

As an example, if the Cap Rate is around

7% to 8% the IRR will be around 12% to
14% for typical income property invest-
ments.

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29. The results of an investment Answer.
analysis of an office building are:
Dropping the purchase price by
Internal Rate of Return (IRR): $680,000 will result in an Internal Rate
8.27% of Return (IRR) changing form 8.27% to
Net Present Value (NPV) at 13%: 13.00%.
$<680,000>
The Net Present Value at 13% will
If the purchase price is reduced change from $<680,000> to $0
by $680,000 the Internal Rate of
Return (IRR) will change from
7.95% to ...?% and the Net Pre-
sent Value (NPV) will be $...?

30. Under what conditions does the Under the following conditions:
Cap Rate come close to being
equal to the Internal Rate of Re- 1) The Net Operating Income (NOI) is
turn (IRR)? constant for many years such as 50
years or more
2) The property is never sold
3) There is no financing or financing is re-
moved from the calculation of the yearly
cash flows

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