Traditional Measures of Investment Worth

1
Chapter 12

• Traditional Measures of Investment Worth

2
Ratio Analysis

• Ratios are employed to gauge the reasonableness
  of relationships between various measures of
  value and performance
• Income multipliers
• Financial ratios

3
Income Multipliers

• Express the relationship between price and either
  gross or net income
• Multiplier analysis permits obviously
  unacceptable opportunities to be weeded out
• Gross income multipliers
• Net income multipliers

4
Financial Ratio Analysis

• Frequently employed to facilitate inter-property
  comparisons.
• Operating ratio
• Break-even ratio
• Debt coverage ratio

5
Traditional Profitability Measures

• Attempt to relate cash investment to expected
  cash returns in some systematic fashionnot
  equally successful
• Overall capitalization rate (free-and-clear rate
  of return)
• Equity dividend rate (Cash-on-Cash rate of
  return)

6
Traditional Profitability Measures

• Brokers rate of return
• Payback period

7
Traditional Profitability Measures

• Shortcomings of traditional measures of
  investment performances
• Ignore cash-flow expectations during the later
  years of the holding period
• Ignore cash-flow expectations from disposal

8
Toward More Rational Analysis

• Five major factors governing the relative
  attractiveness of a real estate investment must
  be incorporated into rational real estate
  investment analysis

9
Toward More Rational AnalysisMajor Factors

• Anticipated stream of net cash flow to the
  investor
• Expected timing of cash receipts
• Degree of certainty with which expectations are
  held
• Yields available from alternative investment
  opportunities
• Investors attitude toward risk

10
Toward More Rational Analysis

• Time-adjusted investment evaluation measures
• Discount expected future cash flows to make them
  more nearly comparable to those receivable in the
  present