Vergil Gunch has just bought an office building in Sacramento for a total acquisition cost of $2,000,000. He has also n

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Vergil Gunch has just bought an office building in Sacramento
for a total acquisition cost of $2,000,000. He has also
negotiated with River City Bank for a 20-year fixed rate
loan. Vergil expects to hold the property for only two years
and then sell it at the market price at that time. Based on the
risk of this investment, Vergil’s after-tax required rate of return
is 9%. The relevant information about the property, the loan
and taxes is summarized in the table below.
Property information
Total acquisition cost
$2,000,000
Land Value
$500,000
Leasable area
20,000 sq. ft.
Annual rent per square
foot
$18.00 and expected to increase by 3% per year
Vacancy and collection losses
10% of potential gross income
Operating expenses
40% of effective gross income
Expected holding period
2 years
Property appreciation rate
3% per year
Gross selling price
based on the appreciation rate
Selling expenses
4% of gross selling price
Financing
Loan amount
$1,400,000
Interest
8% annual interest, with monthly payments
Term
20 years
Lender’s requirements
Debt coverage ratio
1.25 or higher
Breakeven ratio
0.85 or lower
Investor and tax information
Vergil’s marginal income tax rate
28%
Capital gains tax rate
15%
Depreciation recapture tax rate
25%
Vergil’s after-tax required rate of return
9%
Based on given information, please calculate:
1. Vergil’s equity investment.
2. The expected net operating income, before-tax cash flows
and after-tax cash flows from operations in the first two
years.
3. The expected net selling price.
4. The expected before-tax equity reversion and after-tax
equity reversion.
5. Vergil’s after-tax internal rate of return from this
investment. Is this an acceptable investment for him?
6. The debt coverage ratio and the break-even ratio. Would
this loan be approved by River City Bank?