Chapter 18 Finance and Tax Explicit Discounted Cash Flow Analysis

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Chapter 18Finance and Tax ExplicitDiscounted
Cash Flow Analysis
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Review

• Value is a function of
• How much income (NOI)
• When it is received (Income Projections)
• How certain is the income (Discount Rate)

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3 Types of DCF

• Discount NOI and Net Selling Price
• Total income from property (Prev Chapters)
• Finance Explicit DCF (mortgage-equity)
• Values mortgage and equity values separately
• Tax Explicit DCF
• Values mortgage separately
• Values equity cash flows on an after-tax basis

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A Comparison

• Property Productivity Model (NOI)Value V(NOI)
  V(NSP)
• Finance Explicit (Debt-Equity) DCFValue
  V(ADSBTCF) V(Mtg Bal BTER)

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The Key Formulas
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Is It Commonly Used in Practice

• Commonly used in Practice?
• Was common prior to mid-1980s
• Not commonly used in appraisal practice
• Debt terms vary by investor
• Usually look for direct results rather than
  recreate this process
• VERY fundamental investment analysis tool

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Variations

• Income Participation
• Lender gets a portion of cash flow or part of the
  sale price in a addition to Debt Service
• Must subtract additional cash to the lender from
  the equity cash flows
• Interest Only Loans
• Debt Service includes only interest loan
  balance remains the initial balance
• Model cash flows to equity appropriately

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Cash Flows Function of Value

• Some cash flows (Property Taxes) can not be
  estimated without knowing the Value
• Write algebraic equations with Value Vand
  solve for V
• Use an initial guess for value in estimating
  cash flows use an iterative approach to
  make guess value(Use the Goal Seek tool in
  excel)

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Equity Yield vs. Equity Cap Rate
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Tax Explicit Models
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Which Model to Use

• Market Value or Investment Value?
• What does the Market Use?
• Process vs. Direct Market Results
• Most Probable Buyer
• Same Debt/Equity Structure
• Same Tax Structure

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