CFA Practice Question

A property is valued to be \$1 M using the Income Approach. The capitalization rate is 10%. The mortgage payments equal \$72,649 per year of which \$60,000 is interest. Depreciation per year is \$25,000. The income tax rate is 36%. What is the cash flow to the equity investor?
A. \$12,951
B. \$66,000
C. \$21,951
Explanation: Note that in the Income Approach to valuing real estate, the Capitalization Rate is not the same as the discount rate. Rather it is just the ratio between NOI and Value (Price). Therefore NOI = \$1 M * 10% = \$100,000 (To find cash flow to equity, we have to subtract mortgage payment and taxes). Taxes = (100,000 - 60,000 - 25,000) * 0.36 = 5,400. Cash Flow = NOI - Mortgage Payments - Taxes = \$100,000 - \$72,649 - \$5,400 = \$21,951.

User Comment
chantal Taxable income will be 100,000 - 60 000 Interest - 25000 depreciation = 15 000. The taxes = 15,000 x 36%= 5,400\$. When calculating cash flows we don't include depreciation expenses of 25,000 but include the principal repayment of the debt.