Posted: March 15th, 2023

Cash Flow Modelling – Accounting Assignment Task

Cash Flow Modelling - Accounting and finance Assignment Help

Assignment Task

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You are a Capital Markets Associate supporting a team of debt origination professionals at a top Debt Advisory firm based in New York City. A borrower has approached your team with a financing request and provided the following information:

Single tenant office building in downtown NYC
Total area – 250,000 SF
Currently leased at $75.00 PSF per annum NNN with 2 years remaining on the existing lease.
Current market rents are approximately $85.00psf NNN. Assume the space is released at that rate under the following assumptions:
9 months downtime between the current lease of $75psf and the new lease which will be at market or $85psf.
10 year lease commences 9 months after expiration of the initial tenant at market rent with a $5.00 step up in lease rate at the end of year 5 of the lease.
In addition to the downtime of 9 months, there is 6 months’ of rent free at beginning of 2nd lease
Leasing commission equal to 3% of the total or aggregate amount of rent to be collected over entire lease term. The Leasing commission is paid day 1 of the new lease
Tenant improvements of $50.00 psf are paid on day 1 of the new lease
Purchasing the building today is based on a cap of 5.00% of existing lease net rent.
Borrower plans to hold the asset for 10 years and exit at a 4.5?p rate on Year 11 cash flow. Assume selling expenses are 3% of selling price.

After a few weeks of performing financial analysis and preparing a target list of potential lenders, your team takes the borrower’s offering to market. A week later the borrower receives three financing proposals:

Option A: 50% LTV @ 2.5% interest only and therefore no amortization

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Option B: 65% LTV @ 3.00%, monthly pay, fully amortizing based on 30-year amortization

Option C: 75% LTV @ comprising:

Senior: 65% LTV 3.25%, monthly pay, fully amortizing based on 30-year amortization; and
Mezzanine: up to 75% LTV 8.00% and no amortization (75% total minus Senior)

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REQUIRED

What is the borrower’s levered IRR in each case?
Which proposal do you think is more attractive and why?
What loan terms / structural points should the borrower be on the lookout for?

This Accounting and Finance Assignment

To determine the borrower's levered IRR in each case, we need to create a cash flow model.

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First, we need to calculate the net operating income (NOI) of the property.

NOI = Annual rent * occupancy rate – operating expenses
NOI = $75.00 PSF * 250,000 SF * 0.95 (assuming a 5% vacancy rate) – operating expenses
NOI = $17,437,500

Next, we need to calculate the cash flows for each financing option.

Option A:

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Loan amount = 50% * Property value = 50% * ($17,437,500 / 5.00%) = $174,375,000
Annual interest payment = $174,375,000 * 2.5% = $4,359,375
Cash flow = NOI – interest payment = $17,437,500 - $4,359,375 = $13,078,125
Levered IRR = 100 * ((CF / Loan amount)^(1/n) – 1) = 100 * ((13,078,125 / 174,375,000)^(1/10) – 1) = 9.31%

Option B:

Loan amount = 65% * Property value = 65% * ($17,437,500 / 5.00%) = $227,006,250
Monthly payment = $227,006,250 / 360 = $630,573
Cash flow = NOI – monthly payment * 12 = $17,437,500 - $7,566,876 = $9,870,624
Levered IRR = 100 * ((CF / Loan amount)^(1/n) – 1) = 100 * ((9,870,624 / 227,006,250)^(1/10) – 1) = 6.33%

Option C:

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Senior loan amount = 65% * Property value = 65% * ($17,437,500 / 5.00%) = $227,006,250
Senior loan monthly payment = $227,006,250 / 360 = $630,573
Senior loan cash flow = NOI – senior loan monthly payment * 12 = $17,437,500 - $7,566,876 = $9,870,624
Mezzanine loan amount = 75% * Property value - Senior loan amount = 75% * ($17,437,500 / 5.00%) - $227,006,250 = $1,303,125
Mezzanine loan cash flow = NOI - mezzanine loan interest payment = $17,437,500 - ($1,303,125 * 8.00%) = $7,440,000
Total cash flow = Senior loan cash flow + mezzanine loan cash flow = $9,870,624 + $7,440,000 = $17,310,624
Levered IRR = 100 * ((CF / Total loan amount)^(1/n) – 1) = 100 * ((17,310,624 / 228,309,375)^(1/10) – 1) = 8.38%

Based on the calculated levered IRRs, option A has the highest IRR at 9.31%, followed by option C at 8.38%, and option B at 6.33%. Therefore, option A appears to be the most attractive proposal for the borrower.

The borrower should be on the lookout for loan terms and structural points such as prepayment penalties, default clauses, and loan covenants. T