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A property could be sold today for $2 million. It has a loan balance of $1 million and, if sold, the investor would incur a capital gains tax of $250,000.The investor has determined that if it were sold today, she would earn an IRR of 15% on equity for the past 5 years.If not sold, the property is expected to produce an after-tax cash flow of $50,000 over the next year.At the end of the year, the property value is expected to increase to $2.1 million, the loan balance will decrease to $900,000, and the amount of capital gains tax due is expected to increase to $255,000.a. What is the marginal rate of return for keeping the property one additional year?b. What is the decision to make by the investor?

Respuesta :

jepessoa

Answer:

a. What is the marginal rate of return for keeping the property one additional year?

  • 1.82

b. What is the decision to make by the investor?

  • the investor should keep the property one more year since the returns generated by doing so are much higher than the returns the investor requires.

Explanation:

the current gains from selling the property = selling price - loan balance - capital gains tax = $2,000,000 - $1,000,000 - $250,000 = $750,000

if he investor keeps the property for one more year, h/she can earn = selling price - loan balance - capital gains tax + after tax cash flow = $2,100,000 - $900,000 - $255,000 + $50,000 = $955,000

marginal return from holding the investment one more year = $955,000 - $750,000 = $205,000

marginal cost = net investment x IRR = $750,000 x 15% = $112,500

marginal rate of return = $205,000 / $112,500 = 1.82

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