CHAPTER 7

RES 451 - Property Valuation Technique

CASHFLOW APPROACH
Prepared by : Sr. Nur Lesya Firsya Binti Johaimi Ling, MRISM
 Learning outcome

• To calculate the net present value of

property investment

•To calculate the internal rate of return:

equivalent and equated yield
Discounted cashflow (DCF) Techniques

• DCF – a techniques that assist in decisions relating

property investment and appraisal

• Principal application is to compare between choices of

investment

• DCF involves the discounting of future receipts and

expenditures similar to the investment method of
valuation but its allow for inflation, taxation and
frequent changes in the amount of income and receipts

The value of today’s Ringgit = Present Value

 To analyse a DCF, three forms of rate to
choose from:

The rate of return

which the investor
The rate which
The rate which has requires to
could be earned if
to be paid for compensate for the
the capital was
borrowing capital: risk involved, the
invested elsewhere:
the borrowing loss of immediate
rate the opportunity consumption and
cost rate inflation:
the target rate

# the target rate is commonly use in investment appraisal and analysis.

Methods of DCF calculations

• Two principals methods – Net Present Value (NPV)

method and Internal Rate of Return (IRR) method

• NPV – to calculate RM….

NPV method compares the future costs and receipts

on a discounted present Capital Value.

• IRR - to calculate ….%

IRR method shows the return earned on the

investment i.e. ROI
Definition of NPV

Uses discount
rate to get If NPV > 0 ;
Total PV of The greater
value i.e the project/
receipts less the NPV, the
investment
Total PV of • the Present better is an
worth
expenditures Value of investment
undertaking
RM1
Example Question (NPV)

Value a property investment which will produce a rental

income of RM12,000 per annum over 5 years, using
target rate of 10% p.a. The current rental value for
such properties is RM 18,000 per annum and ARY is
7%. The investment requires a capital of RM200,000.
The answer

Year Rental YP @ PV RM 1 @ Total PV

RM 7% 10% RM

1 12,000.00 - 0.9091 10,909

2 12,000.00 - 0.8264 9,917
3 12,000.00 - 0.7513 9,016
4 12,000.00 - 0.6830 8,196
5 12,000.00 - 0.6209 7,451
Reversion 18,000.00 14.29 0.6209 159,708
Capital Value 205,197

Less: Capital 200,000

Net Present Value 5,197

Definition of IRR

The rate at Total PV of

which NPV Equated yield
receipts = Total
equals to 0 vs Equivalent
PV of
yield
NPV = 0 expenditures
Equivalent Yield and Equated Yield

• Equivalent yield - the discount rate or internal rate of

return which, when applied to the income expected over
the investment, without allowing for growth or changes
which opposed to equated yield which allows for growth
before discounting back.
• Equated yield – the discount rate or internal rate of
return which, when applied to the income expected over
the investment, expected future rental changes from
rent review and lease renewals include the variations of
money and inflation.
Example Question (IRR)

• An investor is offered a property investment that

requires an initial capital of RM200,000which will
produce a rental income of RM12,000 per annum over
the next 5 years. The current rental value for such
properties is RM 18,000 per annum and ARY is 7%.
Advise the investor using IRR (Equivalent yield)
calculation.
The answer

R1 R2
Internal Rate of return; the formula

IRR = R1 + { (R2-R1) X NPV R1 }

NPV R1 + NPV R2
Example of IRR
Example of Equated Yield
Example 2 of Equated Yield
Find the Capital Invested Value
Exercise 1

Abu let his property to Bakar for 6 years

since last year. The rental was RM13,500 p.a. (net)
for the first 3 years followed by RM15,800 p.a.
(net) for the next 3 years. The current full rental
value of the property is RM 16,400 p.a. ARY at 6%
and expected rental growth is at 4% p.a.
Calculate the IRR and fair selling price.
Exercise 2

A factory was currently let for 4 years at RM22,000 per annum

(net) with annual reviews. An investor was offered to buy this
investment for RM420,000. The FRV of similar properties is
RM24,000 per annum. Assuming ARY is 6% and rental growth
is estimated at 4% per annum.
Using discounted cash flow approach, calculate the NPV and
the viability of the investment
References

• Enever N & Isaac D (2002). Valuation of Property

Investment, Estate Gazettes.

• Hj Sirat, K (2006). Investment Method of Valuation – A

Workbook, UPENA UiTM

• Millington A.F (2001). An introduction to Property

Valuation, Estate Gazettes

• Johnson, T., Davies, K., Shapiro, E. (2000). Modern

Method of Valuation, Estate Gazettes

• Valuation of investment properties - a frame of

reference for the yield, Danish Property Federation
(2013)