AEP - C2 - Week 2 Slides

8/17/2019 AEP - C2 - Week 2 Slides

1/27

CERTIFICATE PROGRAM

Developed by:

With generous support from:


2/27

PROJECT CASH FLOW AND EVALUATION

COURSE INSTRUCTOR: Jack S. NymanExecutive Director, The Steven L. Newman Real Estate Institute

Zicklin School of Business, Baruch College, The City University of New York

WEEK 2


3/27

WEEK 2: LEARNING OBJECTIVES

Identify revenues and expenses and explain how they aretranslated into value.

Apply an understanding of line items, and their impact on cashflow and value.

Develop a meaningful understanding of cash flow terminology andnotation.

Recognize Creating Value, Generating Efficiency and Saving Money.

Identify and describe the six functions of a dollar.


4/27

WEEK 2: READINGS

Readings

The Energy Management Handbook , Chapter 4: EconomicAnalysis. Doty & Turner, eds.

“Energy Star’s Building Upgrade Manual,” Chapter 3: InvestmentAnalysis. US EPA.

“Lease-Based Analysis,” NYSERDA.


5/27

WHAT IS THE TIME VALUE OF MONEY (TVM)?

Basic premise: a dollar today is more valuable than a dollar tomorrow

An investor/lender who provides a dollar today expects a return on thatdollar tomorrow

Economists have developed mathematical formulas to determine theamount of return that would justify a particular risk

TVM Notation:

• n = Number of Periods

• r or i = Interest Rate

• PV = Present Value

•FV = Future Value

• PMT = Payment

• e$ = Energy Dollar

Source: http://www.investopedia.com/terms/t/timevalueofmoney.asp


6/27

1. Annuity – a stream of fixed payments, paid or received (usuallyreceived) over a period of time.

• Because performing leases yield regular, consistent rentpayments, they may be considered (and treated as) annuities.

2. Interest – the amount of Rent paid for the use of another’s money

and for as long as that amount is owed and outstanding.• Simple Interest is not compounded. When calculating the

interest charge, you apply the annual rate of interest to theoriginal dollar borrowed or invested. Previous interestperiods have no effect and are not applicable when calculatingthe present period.

In formula form:

P x I x N = Simple Interest

TIME VALUE OF MONEY: TERMINOLOGY

Author: Sam Irlander, 2014


7/27

2. Interest , continued.

• Compound Interest , simply put, it is interest on top of interest.

• Each period of accrued interest is added on to the previous baseamount forming a new higher base amount.

• The more frequent the compounding periods, the greater the

amount of compound interest yield (monthly adjustment vs. oneannual adjustment)

• Nominal Rate – The stated rate of interest; no adjustment(s)made concerning the results of compounding. When the amountof compounding period(s) differ from the applicable time ofcomparison (i.e. 1 month vs. 1 year), the interest rate would be

called nominal rate




8/27

2. Interest , continued.• Annual Percentage Rate – commonly referred to as APR. It is a

finance charge that is stated in annual terms rather than lesserperiods (monthly).

• When advertising credit terms, disclosures required byRegulation Z (Truth in Lending/Simplification Act; TILSRA)

include but are not limited to stating the APR• Example:

i. assume your rate of interest is 10% and your principal is$1.00

ii. one annual payment would yield $0.10. Now theinvestment is worth $1.10

iii. monthly compounded interest would yield $.1047. Nowthe investment is worth $1.1047




9/27

3. Principal – The dollar amount loaned or spent at acquisitiona. on loans, it is the present value dollar that is loaned; whileb. on investments, it is the original dollar expended to purchase the asset

4. Term – The period over which a loan is amortized, or for which anasset is expected to be held (the holding period).

a. ‘Term’ can also describe the length of a leasehold.

5. Maturity – The point at which the loan becomes due or payablea. In a borrowing scenario, maturity is when a note or a bill would

otherwise become due

6. Accumulated Value - the total dollar amount of all payments,including interest, by the end of an annuity term5. Hurdle Rate - The minimum rate of return on a project or investment

required by a manager or investor


3 & 4: Author: Sam Irlander; 5 & 6 Source: Investopedia.com


10/27

TIME VALUE OF MONEY: ASSUMPTIONS

Assumptions about TVM (from David R. Frick & Co., CPA)

Money is always invested and always productive so thatreturns can be reinvested at a rate equal to r

The yield curve is flat so that short term interest rates are

equivalent to long term interest rates

Time periods are all of equal length

Payments are all equal, and either all inflows or all outflows

The interest rate is constant throughout the term

Annuities are simple, certain, discrete and ordinary

For more about TVM, see: www.frickcpa.com/tvom/default.asp

Source: http://www.frickcpa.com/tvom/TVOM_Assumptions.asp

http://www.frickcpa.com/tvom/default.asphttp://www.frickcpa.com/tvom/default.asp


11/27

TIME VALUE OF MONEY:

SIX FUNCTIONS OF A DOLLAR

1. Future Value: What will the value of a dollar grow to in n periods at r interest?

2. Present Value: What is the value today of a dollar received n periods in thefuture if one's opportunity cost is r ?

3. Future Value of an Annuity: What will a dollar set aside at the end of eachyear accumulate to after n periods at r interest?

4. Present Value of an Annuity: What is the value of the right to receive adollar each of the next n periods if opportunity cost is r ?

5. Sinking Fund Factor: How much must be set aside in each of n periods at

r interest in order to reach a specific sum in the future?

6. Debt Amortization: What payment is required to amortize a debt of onedollar over n periods at r interest?


12/27

TVM: FUTURE VALUE (1)

What will the value of a dollar growto in n periods at r interest?

∗ 1 +

r 10%;N 2FV $1.00 ∗ 1.10 FV $1.21

Excel: ,,,

(.10,2,0,1)

Application:

Future value calculationscan be used to show theamount of money today’s

energy savings will grow toin a specific number ofyears.

Formula Source: http://owll.massey.ac.nz/maths-and-statistics/finance-formulas.php

http://owll.massey.ac.nz/maths-and-statistics/finance-formulas.phphttp://owll.massey.ac.nz/maths-and-statistics/finance-formulas.phphttp://owll.massey.ac.nz/maths-and-statistics/finance-formulas.php


13/27

TVM: PRESENT VALUE (2)

What is the value today of a dollarreceived n periods in the future ifthe cost is r?

∗ 11 + 10%; 2

$1.00 ∗ 1

1.10

$0.83

Excel: ,,,

Application:

Present value calculations canbe used to show today’s value of

your future energy savings.




14/27

What will a dollar set aside at theend of each year accumulate to aftern periods at r interest?

∗ (1 + ) −1

1 ∗ 1 + 0.10 − 1

0.10

$2.10

Excel: ,,,

Application:

Future value of an annuitycalculations can be used toshow the amount of money

your energy savings over aspecific time frame will beworth at a future date.


TVM: FUTURE VALUE OF AN ANNUITY (3)



15/27

What is the value of the right toreceive a dollar each of the next nperiods if opportunity cost is r?

∗ (1 + ) −1

(1 + )

$1.00 2 ; 10%

$1.74

Excel: , ,,

Application:

Present value of an annuity

calculations can be used to

show the amount of money

your energy savings over a

specific time frame in the

future is worth today.


TVM: PRESENT VALUE OF AN ANNUITY (4)



16/27

How much must be set aside in eachof n periods at r interest in order toreach a specific sum in the future?

(1 + ) −1

1 ∗ 0.11 + 0.1 − 1

$0.48

Excel: (, , 0,−1.00)

Application:

Sinking Fund Factor Paymentcalculations can be used toshow the amount of money

you would need to set asideeach year in order to achievea certain target value at afuture date.


TVM: SINKING FUND FACTOR PAYMENT (5)



17/27

What payment is required toamortize a debt of one dollar over nperiods at r interest?

∗ (1+ )

(1 + ) −1

$1.00 ∗ 0.1 1 + 0.1

1 + 0.1 − 1

$0.58

Excel: (, ,−1,0)

Application:

Debt Amortization Paymentcalculations can be used toshow the amount of money

you would pay each year inorder to completely amortizethe amount of debt used tofund energy efficiencyupgrades.


TVM: DEBT AMORTIZATION PAYMENT (6)



18/27

Use or create an Excel model to calculate cash flows.

Apply the terms and associated costs.

Note: This cash flow does not include the time value of money.

Year 0 1 2 3 4 5 6 7 8 9 10

Acquisition Cost (2,000,000)

Utilization Cost (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000)

Energy Savings 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000

Net Annual Savings 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000

Residual Value 50,000

Cash Flows (2,000,000) 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 450,000

HOW TO CALCULATE PROJECT CASH FLOWS


19/27

Net Present Value (NPV) is the difference between the presentvalue of cash inflows and the present value of cash outflows.

NPV is used in capital budgeting to analyze the profitability of aninvestment or project.

NPV analysis is sensitive to the reliability of projections aboutfuture cash inflows that an investment or project will yield.

NPV formula:

=

(1 + ) −

Source: http://www.investopedia.com/terms/n/npv.asp#axzz2BkUNo2EJ

WHAT IS NET PRESENT VALUE (NPV)?

http://www.investopedia.com/terms/n/npv.asphttp://www.investopedia.com/terms/n/npv.asp


20/27

The Net Present Value (NPV) of a project is based on the project’sexpected impact on the value of the company.

Projects with a positive NPV are expected to increase that value

Projects with a negative NPV are expected to decrease that value

The NPV Decision Rule states, in short, that:

A project with a positive NPV should be accepted

A project with a negative NPV should be rejected; and

Among mutually exclusive projects, the project with the greatest

positive NPV should be chosen.

THE NPV DECISION RULE


21/27

In Excel: =NPV(r, cash flows)

In this example the discount rate is 9%

(This is the approximate risk-cost of capital in 2012)

By applying a discount rate of 9%, the NPV is positive

Therefore, you would pursue the project

Year 0 1 2 3 4 5 6 7 8 9 10



Energy Savings 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000

Net Annual Savings 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000Residual Value 50,000

Cash Flows (2,000,000) 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 450,000

r 9%

NPV 539,618.00

CALCULATING NPV:

STANDARD DISCOUNT RATE


22/27

In Excel: = NPV(r, cash flows)

In this example the discount rate is 8%

Green projects merit a lower discount rate than standard projectsbecause of the long-term value that they add.

By applying the energy savings discount rate of 8%, the NPV is a

greater positive value than the 9% standard discount rate

Therefore, you would pursue this higher NPV project

Year 0 1 2 3 4 5 6 7 8 9 10



Energy Savings 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000



Cash Flows (2,000,000) 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 450,000

r(e) 8%

NPV $654,807.62

9% Discount Rate NPV $539,618.00

Change in NPV $115,189.62

% Change in NPV 21.35%

CALCULATING NPV:

ENERGY SAVINGS DISCOUNT RATE


23/27

Year 0 1 2 3 4 5 6 7 8 9 10

Acquisition Cost (2,000,000)Utilization Cost (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000) (100,000)

Energy Savings 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000



Cash Flows (2,000,000) 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 450,000

r 9%

NPV 539,618.00

Year 0 1 2 3 4 5 6 7 8 9 10



Energy Savings 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000



Cash Flows (2,000,000) 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 450,000

r 15%

NPV 0.00

Year 0 1 2 3 4 5 6 7 8 9 10



Energy Savings 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000



Cash Flows (2,000,000) 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 450,000

r 22%

NPV (328,050.53)

CALCULATING NPV: EXAMPLES


24/27

WHAT IS THE INTERNAL RATE OF RETURN?

Internal Rate of Return (IRR) is a commonly-used concept in project and

investment analysis. The IRR of a project or investment is the discount rate that results in an NPV

of zero.

If the company’s actual cost of capital (discount rate) is lower than the IRR,

the project or investment should be undertaken.

Accept the project if the IRR > Hurdle Rate.

In Excel, IRR function: =IRR(cash flows)

Year 0 1 2 3 4 5 6 7 8 9 10



Energy Savings 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000 500,000



Cash Flows (2,000,000) 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 450,000

IRR 15.3%

Source: http://www.environment.ucla.edu/media_IOE/files/Retrofitting-Commercial-Real-Estate-30-mlg.pdf

http://www.environment.ucla.edu/media_IOE/files/Retrofitting-Commercial-Real-Estate-30-mlg.pdfhttp://www.environment.ucla.edu/media_IOE/files/Retrofitting-Commercial-Real-Estate-30-mlg.pdf


25/27

INTRODUCTION OF THE ENERGY DELTA


26/27

WEEK 2: IN-CLASS EXERCISES

In the Module, locate the Excel file containing embedded formulas forthe functions of a dollar. The file also includes a cash-flow table for anew energy-saving hot water project. Experiment with differentscenarios by altering your acquisition costs and tax incentives.Observe how your variations impact Cash Flow, Net Present Value(NPV), and Internal Rate of Return (IRR).

Write up a brief description of your observations. Discuss how changesin tax rates can impact the value of new investments in energy-efficienttechnology. How else may incentives be created, eliminated, or shifted?Besides raising rents, how might building owners get tenants to share

in the costs of acquiring energy-saving improvements?


27/27

WEEK 2: HOMEWORK

1. Describe the NPV decision rule, and explain the rationale behind it.How is the rule used by real estate owners and managers tochoose between competing proposals for their portfolios?

2. Explain the rationale that underpins the Time Value of Money

concepts that were discussed in class. What is the basicassumption that underpins TVM analysis? Provide two or threeexamples of situations in which specific TVM principles wouldplay an important role in the financial analysis of an investment.

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AEP - C2 - Week 2 Slides

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