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

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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%
Please calculate:
The expected net operating income, before-tax cash flows and
after-tax cash flows from operations in the first two years.