ATIRR Unlevered: Income taxes are taken into account in the calculation of IRR.

This is a continuation Part I. The additional information is:

75% of Mr. Beyer’s purchase price of $92,000,000 is attributable to the improvements (the building) and will be depreciated on a 39-year straight-line basis. As you know, depreciation is a deduction for purposes of calculating taxable income. (The 25% portion of the price attributable to land is, of course, not depreciable.)

The front-end closing costs of $600,000 are capitalized and amortized evenly over his anticipated five-year holding period. Closing costs are a deductable item.

The income tax (the tax on each year’s taxable income from operations) rate is 36%.

Gains Tax: His capital gain (the net sales proceeds in excess of his depreciated basis) is segmented into (a) the net sales proceeds in excess of his purchase price, which is taxed at a rate of 15%, and (b) the amount of depreciation he has taken during his ownership, which is taxed at a rate of 20%.

The $3,500,000 capital expenditure in the fifth year will not be depreciated by Mr. Beyer since it is made during the same period as his disposition of the property.

What is Mr. Beyer’s after-tax IRR (ATIRR)?

Shown in Excel

(PART 1)

Unlevered BTIRR problem

The property is a specialty retail property (which is interesting, but not relevant to the solution). Mr. Beyer is planning to acquire the property, hold it for five years and then sell it at the end of the fifth year.

* The first year net operating income (NOI) is projected to be $8,460,750. Mr. Beyer is projecting that, based on increasing base rents and increasing percentage rents, his NOI will increase at a compounded annual rate of 4%.

* His closing costs (legal, recording, appraisal, environmental, engineering, title, etc.) will come to $600,000. These closing costs will be expended simultaneous to taking title.

* In the fifth year of the holding period, in order to prepare the property for disposition, Mr. Beyer intends to spend $3,500,000 in property upgrade, and he builds in that assumption to his numbers. This capital expenditure is, of course, an increase in his equity investment.

* Mr. Beyer projects his sale to the next purchaser at the end of the fifth year. The sales price will be determined by utilizing a residual or terminal capitalization rate of 9.15% of the projected sixth year NOI (rounded to the nearest $100,000). After all, the next buyer is buying future income, not past income. But Mr. Beyer also projects a cost of sale (legal, marketing, brokerage) of an amount equal to 2% of the gross sales price. This cost of sale will be deducted from his gross sale price to arrive at net sales proceeds.

If all of Mr. Beyer’s projections are accurate, and if he pays $92,000,000 for this property, what will be his before tax IRR (BTIRR)?