Value off IRR
Anyone ever get a case study that simply states to value the property at a predetermined IRR? Basically, have a T-12 and debt terms and be told to model a 5 year hold (income/expense projections and terminal cap my call while having to explain my inputs) and value the deal at a 18% IRR. Would the best way to do this be to do the income & expense UW with a dummy purchase price in an input tab only to back into the actual value via goal seeking the purchase price cell in the model to a leveraged 18% IRR in my proforma tab?
Yeah, you basically just use a goal seek on the purchase price to get the target IRR, unless stated otherwise
Before I give you the answer, let’s step back for a moment. Remember that conceptually, the IRR reflects the time value of money. More specifically, in this case study it is reflecting the investor’s perception of the time value of their money or said differently, their cost of equity. IN more simple terms, the investor has a return they want to achieve to give you, the presumed Sponsor, their capital.
So, as your said, one way to do this is to set up the acquisition price as an input and then use Excel to solve back to the pre-determined IRR.
However! A better way to do this that more clearly illustrates you understand the concept is to forecast the forward cash flows and then discount those back to a Net Present Value (NPV) to determine what you can purchase the asset for using the pre-determined cost of capital as the input. Thus, the acquisition price is a formula resulting from this input. As the cost of capital lowers (let’s say you find a high-net-worth individual that only needs a 13% IRR), then the price you can pay increases and you can still achieve the target return.
This better reflects the idea of the case study, imo. And you can better talk towards the concept first and the model second. This is the difference between an Analyst and beyond.
This is basically the entire concept of IRR/NPV…
You wouldn’t goal seek, you would just discount the cash flows by 18% each year of the hold period.
Would you not just take the cashflows and throw in 18% as the discount rate in the NPV function? Been a bit since I was elbow deep in excel but isnt that the relationship between the IRR and NPV functions?
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