VERY Basic Financial Modeling Question Regarding Time 0 Cash Flows and Initial Investment
I need a small favor. I have a very basic question about discounted cash flow modeling. I think I know the answer, and it is probably obvious, but I have been thinking about it so much that I have confused myself. This issue is very important to a financial model I have created for the acquisition of a property so I want to make sure I get it right.
If you have 10 minutes to spare, please look at the attached spreadsheet and fill in the spaces highlighted in yellow. This is essentially a VERY simplified version of the issue I am having in my real model regarding time 0 cash flows and the initial investment.
I would appreciate responses ASAP because I have people waiting for the real model and I told them I would get it to them today if at all possible.
Let me know if you have any questions.
Thanks, Carlos
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DCF Model 39.17 KB | 39.17 KB |
Land: (100) Debt: 80 PIC: 20 Investment: (100)
I completely understand your understand your response. However, the question I still have is whether in the valuation section it is appropriate to use the full price of the land ($100) rather than the equity investment ($20)?
Gotcha. In that case, I think (20) would be correct. Since you have (80) in the last year for the repayment of debt, using (100) in Year 0 would essentially be double-counting the (80). It seems like you are right, at least going off of your simplified example.
If you want a levered IRR use (20) as the investment in the valuation section and if you want an unlevered IRR take (100) as the investment in the valuation section.
I want to show the IRR to the equity holders. I believe that is what you mean by "levered IRR" and thus $20 as the investment. Correct?
Correct; the levered IRR would correspond to the equity investor. Use ($20) as the investment. If the equity is coming from more than one source this levered IRR would be a project level levered IRR and you would have to model a waterfall to get LP vs GP IRRs. I am assuming, however, that in this simple model there is one source of debt and one source of equity.
Thanks. Correct. I understand that the IRR is on a project basis, and I do have an equity waterfall to account for varying equity investments, promotes, and prefs.
What I am struggling with, perhaps because I am overthinking it, is that I am showing an equity investment of -$20. However, in the Cash Flow Statement, I am also showing a positive cash flow of $20 as a result of an increase in PIC of +$20. Therefore, in the Valuation, the investment of -$20 and the cash flow of +$20 cancel out. For some this reason this feels like I am negating the -$20 investment and calculating the IRR as if there were no equity investment (because the investment and cash flow cancel each other out). I would attach the spreadsheet that makes this explicit but I dont know if there is a way to add an attachment to a reply. Thx.
I believe you are overthinking it. I will attempt to answer what I believe is going on in your head, so I hope this makes sense. The +$20 in the CF Statement that you think is cancelling the -$20 in the investment has already been cancelled out by the -$100 in land and +$80 in debt. Take a look at your formula; you're summing investment with CHANGE in cash not PAID in cash. The value you're summing to the investment in year 0 is 0 because the +20 has already been "cancelled" out. Thus, when you sum your investment with your change in cash your net result is -$20 - the exact amount of your equity investment. I believe your confusion lies in the importance of change rather than paid in the CF statement. Hope this helps.
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