The Table Below Shows Two 10-Year Cash Flow Projections (In

question 11

Essay

The table below shows two 10-year cash flow projections (in $ millions, including reversion) for the same property. The upper row is the projection that will be presented by the broker trying to sell the building, the bottom row is the realistic expectations. Suppose that it would be relatively easy for any potential buyers to ascertain that the most likely current market value for the property is about $10 million. What is the most likely amount of "disappointment" in the ex post annual rate of total return earned by an investor who buys this property believing the broker's cash flow projection?
$$\begin{array} { | l | r | r | r | r | r | r | r | r | r | r | } \hline \text { Year } & 1 & 2 & 3 & 4 & 5 & 6 & 7 & \mathbf { 8 } & 9 & 10 \\\hline \text { Presert } & \$ 1.00 & \$ 1.03 & \$ 1.06 & \$ 1.09 & \$ 1.12 & \$ 1.15 & \$ 1.19 & \$ 1.22 & \$ 1.26 & \$ 14.7 \\\text { ted } & 00 & 00 & 09 & 27 & 55 & 93 & 41 & 99 & 68 & 439 \\\hline \text { Realist } & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 11.0 \\\text { ic } & 00 & 00 & 00 & 00 & 00 & 00 & 00 & 00 & 00 & 000 \\\hline\end{array}$$


(a) 0.00%
(b) 1.00%
(c) 3.00% = Presentation IRR - Realistic IRR = (10% + 3%) - (10% + 0%) = 13% - 10%.
(d) 26.68%

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Definitions:

Income Tax Expense

This represents the amount of money a company expects to pay in income taxes based on its taxable income for a given period.

Straight-Line Depreciation

A technique for laying out the expense of a solid asset over its viable life in consistent annual segments.

Initial Investments

The upfront expenses incurred when starting a new project, business, or investment.

Income Taxes

Taxes levied by governments on the income generated by businesses or individuals within their jurisdiction.