The internal rate of return on an investment is the discount rate at which:
Correct Answer
C) The present value of cash flows equals the initial investment
Why this is correct: The Internal Rate of Return (IRR) is the discount rate that makes the net present value of all projected cash flows (including the reversion) equal to the initial equity investment. In other words, it is the rate at which Present Value of Cash Flows = Initial Investment. Why the other choices are wrong: "The reversion exactly equals the original purchase price" is not the definition of IRR. "The property's NOI equals its debt service" describes a Debt Coverage Ratio of 1.0. "The expense ratio reaches the market average" is unrelated to IRR calculation. Exam tip: IRR is the 'solve-for' discount rate in a DCF that makes NPV = 0. It represents the project's yield to the equity investor.
Why This Is the Correct Answer
Why this is correct: The Internal Rate of Return (IRR) is the discount rate that makes the net present value of all projected cash flows (including the reversion) equal to the initial equity investment. In other words, it is the rate at which Present Value of Cash Flows = Initial Investment. Why the other choices are wrong: "The reversion exactly equals the original purchase price" is not the definition of IRR. "The property's NOI equals its debt service" describes a Debt Coverage Ratio of 1.0. "The expense ratio reaches the market average" is unrelated to IRR calculation. Exam tip: IRR is the 'solve-for' discount rate in a DCF that makes NPV = 0. It represents the project's yield to the equity investor.
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Previous Question
A developer proposes a mixed-use project with phased leasing and irregular cash flows: $0 NOI in Years 1–2 (leasing-up period), $420,000 in Year 3, $610,000 in Year 4, and $750,000 in Years 5–10. The reversion is $9.2 million at the end of Year 10. Which statement best explains why a single overall capitalization rate would be inappropriate for valuing this property?
Next Question
A building's rent roll totals $120,000 at full occupancy. Vacancy and collection loss is 5% and laundry income adds $4,800. What is effective gross income?