A house worth $900k is expected to earn $50k pa gross rent revenue and incur rental costs of $10k pa over the next year. Note that the units 'k' (Greek kilo) represent thousands. Assume that these cash flows are expected one year from now, so they’re received and paid annually in arrears.If the gross rent revenue and costs increase by 5% per annum and houses can be valued as a perpetuity, what is the internal rate of return (IRR) of this house asset? Ignore taxes.Question 1Select one:a.0.2% pab.9.444444% pac.9.916667% pad.19.444444% pae.40% pa
Question
A house worth 50k pa gross rent revenue and incur rental costs of $10k pa over the next year. Note that the units 'k' (Greek kilo) represent thousands. Assume that these cash flows are expected one year from now, so they’re received and paid annually in arrears.If the gross rent revenue and costs increase by 5% per annum and houses can be valued as a perpetuity, what is the internal rate of return (IRR) of this house asset? Ignore taxes.Question 1Select one:a.0.2% pab.9.444444% pac.9.916667% pad.19.444444% pae.40% pa
Solution
The internal rate of return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. It is used to evaluate the attractiveness of a project or investment.
Here are the steps to calculate the IRR:
-
Calculate the net cash flow for each year: This is the gross rent revenue minus the rental costs. Given that both the gross rent revenue and costs increase by 5% per annum, the net cash flow for the first year would be 10k = $40k. For subsequent years, this would increase by 5% per annum.
-
Since the house can be valued as a perpetuity, the present value of these cash flows can be calculated using the formula for a growing perpetuity: PV = CF / (r - g), where CF is the cash flow for the first period, r is the discount rate (or IRR in this case), and g is the growth rate.
-
Set the present value equal to the cost of the house and solve for r. This gives us the equation 40k / (r - 0.05).
Solving this equation for r gives us an IRR of approximately 9.444444% pa. So, the correct answer is b. 9.444444% pa.
Similar Questions
A firm is considering a project that requires an initial outlay of £50,000. It will have a life of 5 years. It will generate free cash flows of £20,000 in years 1 and 2 and £5,000 in years 3 – 5.What is this project’s Internal Rate of Return (IRR) in %? [to 2 decimal places e.g. 7.54%]
Internal Rate of Return (IRR) is defined as the discount rate at which Net Present Value (NPV) of the cash flows is equal to zero.Group of answer choicesTrueFalse
The projected NOI for a property purchased at S1.2 million is S100,000 in Year 1. The NOl isexpected to increase at a rate of 5% per annum, The property is sold at the end of Year 2 for$1.5 million. Given a safe reinvestment rate of 5%, what is the modified internal rate of return(MIRR) of this project?
Which of the following are correct statements about the internal rate of return (IRR)? (Check all that apply.)Multiple select question.The higher the IRR, the better.IRR uses the time value of money.IRR uses accrual income as the measurement basis.IRR is expressed in dollars.
A firm is considering a project that requires an initial outlay of £65,000. It will have a life of 6 years. It will generate free cash flows of £10,000 in years 1 – 4 and £20,000 in years 5 and 6. The firm has a cost of capital of 8%.Using Internal Rate of Return (IRR), should it accept or reject this project?
Upgrade your grade with Knowee
Get personalized homework help. Review tough concepts in more detail, or go deeper into your topic by exploring other relevant questions.