An investor has three possible scenarios for a project as follows:

Pessimistic – NOI will be $220,000 for the first year, and then decrease by 3 percent per year over a five-year holding period. The property will sell for $1.7 million after five years.

Most likely – NOI will be level at $220,000 per year for the next five years and the property will sell for $2.5 million

Optimistic – NOI will be $220,000 the first year and increase 3 percent per year over a five-year holding period. The property will sell for $2.8 million.

The asking price of the property is $2.2 million. The investor believes that there is a 30% probability of the pessimistic scenario, a 50% probability for the most likely scenario, and a 20% probability for the optimistic scenario.

(a) Compute the IRR for each scenario and the expected IRR for the project.

(b) Compute the variance and standard deviation of the IRRs.

(c) Would this project be better than one with a 12 percent expected return and a standard deviation of 3 percent?

(d) If a loan of $1.2 million is used to purchase the property at a 8 percent interest rate with a 15 year term, calculate the expected IRR and the standard deviation of the return on equity (ignore taxes). Contract your findings with those obtained in (a) and (b) above.