Question 01

1. Site Analysis
– Survey of site to determine net useable land area
– Zoning of site and related constraints
– Availability of utilities to site
– Subsurface soil conditions
– Preliminary report
2. Initial Concept
– Establish target land development concept in terms of developer’s goals, permitted
zoning, and developer’s financial resources
3. Demand Analysis
– Evaluate the economic base that supports the community in which project is
located:
 Population projections
 Employment projections
 Income Projections
– Study the demand forces that pertain to your specific project type
– Analyze the competitive market within which you must operate
4. Supply Analysis
– Determine market area related to project
– Analyze the present and future inventory of product that you will be competing
with in relation to your delivery date
– Determine product mix in relation to competitive rents, pricing, and amenities

5. Specific Development Scheme

– With architects and engineers, developer relates concept to market conditions, with
a specific development scheme, land use plan
6. Cost Estimates
– Based on a specific plan, developer then estimate all hard and soft costs based on
the “bid date” of the project
7. Financial Structure
– Reviews profitability for go/no go decisions
– Review mortgage loan ratios, terms of borrowing, equity position, tax
considerations
– Determine phasing, if any, and absorption rates
8. Rate of Return Analysis
– Review risk factors related to project
– Review length of investment period
– Determine rate of return “on” and “of” the investment
Question 02

State of the economy NOI Debt Service BTCF EDR Probability

Optimistic 16,000,000.00 2,629,475.54 13,370,524.46 0.17 0.2 0.03
Most likely 14,000,000.00 2,629,475.54 11,370,524.46 0.14 0.6 0.09
Pessimistic 12,000,000.00 2,629,475.54 9,370,524.46 0.12 0.2 0.02
14.21%

State of the economy NOI Debt Service BTCF EDR Probability

Optimistic 16,000,000.00 11,745,939.17 4,254,060.83 0.21 0.2 0.04
Most likely 14,000,000.00 11,745,939.17 2,254,060.83 0.11 0.6 0.07
Pessimistic 12,000,000.00 11,745,939.17 254,060.83 0.01 0.2 0.00
11.27%

State of the economy EDR EDR-E(EDR) (EDR-E(EDR))^2 Probability

Optimistic 0.17 0.03 0.001 0.2 0.00013
Most likely 0.14 - - 0.6 -
Pessimistic 0.12 (0.03) 0.001 0.2 0.00013
0.00025

State of the economy EDR EDR-E(EDR) (EDR-E(EDR))^2 Probability

Optimistic 0.21 0.10 0.010 0.2 0.00200
Most likely 0.11 - - 0.6 -
Pessimistic 0.01 (0.10) 0.010 0.2 0.00200
0.00400

Financing Option E (EDR) σ

Option 1 : 20/80 Debt to Equity 14.21% 0.015811
Option 2 : 80/20 Debt to Equity 11.27% 0.063246

The answer would vary according to the risk and return preferences of each investor. If the
investor is a risk taker option 1 will be selected. Otherwise option 2 is available with low return
and low risk.
Question 03
a.
1. Liquidity ratios – Measure Company’s capability to pay its payable current liabilities.
2. Leverage ratios – measure how the company is financed from creditors’ resources.
3. Activity ratios – measure how efficiently company uses its own resources.
4. Economy ratios – measure relation between revenues and expenses, that is, they show how
much revenue is achieved per unit of expenses.
5. Profitability ratios – measure the return of the invested capital and show the highest managerial
efficiency.
Generally, good management includes two criteria: security (liquidity, financial stability and indebt
ness) and efficiency (profitability)

(i) Ratios help in analyzing the performance trends over a long period of time.

(ii) They also help a business to compare the financial results to those of competitors.

(iii) Ratios assist the management in decision making.

(iv) They also point out problem and weak areas along with the strength areas.

(v) Ratios to help to develop relationships between different financial statement items.

(vi)Ratios have the advantage of controlling for differences in size. For example, two businesses
may be quite different in size but can be compared in terms of profitability, liquidity, etc., by the
use of ratios.

b.
i) Operating Expense Ratio
Operating Expense Ratio= (Operating Expense/ Net Sales) x 100

This ratio is used to measure the operational efficiency of the management. It shows whether
the cost component in the sales figure is within normal range. A low operating ratio means high
net profit ratio i.e., more operating profit. OER 0.6 is 60% of net sales goes to recover operating
Expenses.
ii) Break-even cash flow ratio
Break-even cash flow ratio= (Debt Service + Operating Expenses) / Gross Operating Income
Lenders commonly look for a break-even ratio of 85% or less for them to consider underwriting
a loan on investment real estate. That is, they want the assurance that rents can decline at least
15% before the property breaks even (100 - 85).
Since the subject income property has a BER of 90%, it means that the income stream can only
drop off by 10% before the cash flow breaks even with the mortgage payment. So it might not
qualify for a loan from a bank that holds to that standard.

iii) Debt coverage ratio

Debt coverage ratio = Net operating income / Annual debt service
The ratio of net operating income compared to annual debt service, which includes principal and
interest payments. Theratio is used by lenders to evaluate loans on income-
producing property.A ratio of 1.2 or better will usually support theextension of credit.
Question 04

CF (Rs. Millions) Total PV ( Rs. Millions)

Year Machine A Machine B PVF (10%) Machine A Machine B
0 (25) (40) 1.00 (25.00) (40.00)
1 - 10 0.91 - 9.09
2 5 14 0.83 4.13 11.57
3 20 16 0.75 15.03 12.02
4 14 17 0.68 9.56 11.61
5 14 15 0.62 8.69 9.31
12.41 13.61

Calculation of Profitability Index

Machine A Machine B
PV of Cash inflow 37.41 53.61
PV of Cash outflow 25.00 40.00
1.50 1.34

Calculation of Payback Period

CF (Rs. Millions) Total PV ( Rs. Millions)

Year Machine A Machine B Machine A Machine B
0 -25 -40
1 10 10
2 5 14 5 24
3 20 16 25 40
4 14 17 39 57
5 14 15 53 72

In both cases payback period is 3 years

Present Value Cumulative Present Value

Year Machine A Machine B Machine A Machine B
0 (25.00) (40.00)
1 - 9.09 9.09
2 4.13 11.57 4.13 20.66
3 15.03 12.02 19.16 32.68
4 9.56 11.61 28.72 44.29
5 8.69 9.31 37.41 53.61
 Present Value
Machine A Machine B
(25.00) (40.00)
19.16 32.68
(5.84) (7.32)
9.56 11.61

5.84 7.32
9.56 11.61
0.61 0.63
3.61 years 3.63 years

Machine A Machine B Choice

NPV 12.41 13.61 B
Profitability Index 1.50 1.34 A
Payback Period 3 years 3 years Indifferent
Discounted Payback Period 3.61 years 3.63 years A

Because of rising demand of the Company’s product, Machine B should be the choice as it has
higher capacity and NPV is also higher.
Question 05

a. Special Economic Characteristics of Real Estate Resources

Fixed Location
Uniqueness
Inter-dependence of Land Uses
Long Life
Long - term Commitments
Large Transactions
Long Gestation Period

b. Net Present Value (NPV) & Internal Rate of Return

The difference between present value of cash inflows and present value of cash outflows
is equal to NPV; the firm’s opportunity cost of capital being the discount rate.

• Acceptance rule
accept if NPV> 0 (NPV is positive)
reject if NPV< 0 (NPV is negative)
project may be accepted if NPV = 0

The discount rate which equates the PV of an investment’s cash inflows and outflows is
its internal rate of return

• Acceptance rule
accept if IRR > K
reject if IRR < k
project may be accepted if IRR = K

c. The Mortgage Lending Process

STEP 1 - The Application: The borrower submits in writing a formal request for a specific
type of mortgage on a specific property

STEP 2 – Under writing analysis: The lender analyses the borrower, the project and other
market conditions using various criteria & makes a decision to lend or not.

STEP 3 - Commitment: Assuming that the decision is made to lend, the lender submits a
formal commitment to the borrower.

STEP 4 - Closing - After all parties meet the various requirements, the loan is closed.
d. Impact of sources of financing on expected rate of return and risk
The financing of a real estate investment involves the use of two types of funds: debt
(mortgage) and equity.
The use of debt to finance an investment can have two impacts: the rate of return to the
equity position and the expected risk of the equity position.
Thus the investor must face this question: Does the increase in the expected return offset
the increased risk? If it does, the investor should use the debt. If it does not, the debt
should not be used
An investor must ask himself or herself if the increase in return is enough to set off the
increased risk. The answer would vary according to the risk and return preferences of each
investor.

e. Due Diligence in Real Estate Investment Risk Analysis

The term due diligence is used in the real estate investment community to describe the
investigation that an investor should undertake when considering the acquisition of a
property.
Although this process should be followed by any investor, it is particularly important when
a firm is making investments on behalf of other investors. Essentially, due diligence is the
process of discovering information needed to assess whether or not investment risk is
suitable given a set of investment objectives.