Question

3. Fourth Federal Savings recently foreclosed on a property that one of its borrowers defaulted on the loan. Fourth Federal is offering the property for $100,000. If you buy the property, you believe that you will have to spend S15,000 on various acquisition-related expenses. In addition, you will have to spend an average of $2,000 per month during the next twelve months for repairs, maintenance and utilities in order to prepare it for sale. Fourth Federal wants to get this real estate off of its books quickly, so it is willing to provide $90,000 in financing at five percent interest for twelve months in an interest only loan with a balloon payment due at the time of the sale. You believe that you can sell this property for a net price (after selling expenses) of S140,000. If you want to earn a 20 percent annualized rate of return on your investment compounded monthly, would this be a good investment? That is, what would be your rate of return on this investment, compounded monthly, over the next year, if you purchase this property?

Answer 1

After plotting the net cash flow as shown in the below excel sheet, we see that IRR is negative and it is infact -9.14% annualized. Thus this is not a good investment.

1 Fourth Federal 2 Months 3 Property Price 4 Acquiistion related expenses (15,000) 5 Repairs Maintenance Utilities 6 Financing 7 Interest payment 8 Baloon Payment at last 0 10 12 $(100,000) $ (2,000) (2,000) (2,000) (2,000) (2,000) (2,000 (2,000) (2,000) S (2,000) S (2,000)$ (2,000) (2,000) $90,000 $ (375) $ (375) $ (375) $ (375) $ (375) $ (375) $ (375) $ (375) $ (375) $ (375) $ (375) $ S (90,000) (375)--596"SB$6/12 10 Sale of Asset 140,000 25,000)(2,375) (2,375) (2,375) (2,375) (2,375) $(2,375) (2,375)(2,375) (2,375) (2,375) (2,375) 47,625-SUM(N3:N10) 12 Net Cash Flow 13 14 9.14%